SEC Info - Nuance Communications, Inc.

SEC Info℠

Home

Help

Please Sign In

Nuance Communications, Inc. – ‘424B1’ on 2/11/03

On: Tuesday, 2/11/03, at 8:08am ET · Accession #: 950135-3-866 · File #: 333-100647

  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 2/11/03  Nuance Communications, Inc.       424B1                  1:568K                                   Bowne of Boston/FA

Prospectus — Rule 424(b)(1)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B1       Scansoft Inc.                                        174    888K

Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Accounting for Stock-Based Compensation Amortization of goodwill and other intangible assets Business Capitalization Certain Relationships and Securities Transactions Changes in the Net Investment of the Philips Group Combined Balance Sheets Combined Statements of Cash Flows Combined Statements of Operations and Comprehensive Loss Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Description of Capital Stock Dilution Dividend Policy Experts Forward-Looking Statements Income (loss) before income taxes Income (loss) from operations Index to Financial Statements Legal Matters Loss from Operations Management Management's Discussion and Analysis of Financial Condition and Results of Operations Merrill Lynch Net income (loss) Net investment of the Philips Group Net Loss Net loss per share Notes to Consolidated Financial Statements Notes to Financial Statements Notes to the Combined Financial Statements Notes to Unaudited Consolidated Financial Statements Notes to Unaudited Pro Forma Combined Financial Statements Offering, The Other Philips Preferred Stock Price Range of Common Stock Principal and Selling Stockholders Prospectus Summary Report of Independent Accountants Risk Factors ScanSoft ScanSoft, Inc Schedule II Selected Consolidated Financial Data Selected Quarterly Operating Results Shares Eligible for Future Sale Statement of Revenue and Direct Operating Expenses for the Nine Months Ended September 30, 2001 Summary Consolidated Financial Data The Offering Total Total revenue Trademarks and Other Information Unaudited Pro Forma Combined Statement of Operations for the Nine Months Ended September 30, 2002 Unaudited Pro Forma Combined Statement of Operations for the Year Ended December 31, 2001 Underwriting Use of Proceeds Valuation and Qualifying Accounts and Reserves Warrants Where You Can Find More Information Xerox
1	1st Page - Filing Submission
3	Prospectus Summary
"	ScanSoft
5	The Offering
6	Summary Consolidated Financial Data
7	Risk Factors
15	Forward-Looking Statements
16	Trademarks and Other Information
"	Use of Proceeds
17	Price Range of Common Stock
"	Dividend Policy
18	Capitalization
19	Dilution
20	Selected Consolidated Financial Data
22	Selected Quarterly Operating Results
23	Management's Discussion and Analysis of Financial Condition and Results of Operations
26	Total revenue
27	Amortization of goodwill and other intangible assets
28	Income (loss) from operations
"	Income (loss) before income taxes
"	Net income (loss)
30	Loss from Operations
31	Net Loss
41	Business
52	Management
70	Certain Relationships and Securities Transactions
72	Principal and Selling Stockholders
74	Description of Capital Stock
"	Preferred Stock
75	Warrants
"	Xerox
76	Merrill Lynch
"	Philips
78	Shares Eligible for Future Sale
79	Underwriting
80	Total
82	Legal Matters
"	Experts
"	Where You Can Find More Information
83	ScanSoft, Inc
"	Index to Financial Statements
84	Report of Independent Accountants
85	Consolidated Balance Sheets
86	Consolidated Statements of Operations
87	Consolidated Statements of Stockholders' Equity
88	Consolidated Statements of Cash Flows
89	Notes to Consolidated Financial Statements
94	Net loss per share
"	Accounting for Stock-Based Compensation
98	Other
115	Schedule II
"	Valuation and Qualifying Accounts and Reserves
120	Notes to Unaudited Consolidated Financial Statements
132	Combined Balance Sheets
133	Combined Statements of Operations and Comprehensive Loss
134	Changes in the Net Investment of the Philips Group
"	Net investment of the Philips Group
135	Combined Statements of Cash Flows
136	Notes to the Combined Financial Statements
155	Statement of Revenue and Direct Operating Expenses for the Nine Months Ended September 30, 2001
156	Notes to Financial Statements
167	Unaudited Pro Forma Combined Statement of Operations for the Year Ended December 31, 2001
168	Unaudited Pro Forma Combined Statement of Operations for the Nine Months Ended September 30, 2002
169	Notes to Unaudited Pro Forma Combined Financial Statements

424B1 1st Page of 174 TOC ↑Top Previous Next ↓Bottom Just 1st
FILED PURSUANT TO RULE 424(b)(1)
REGISTRATION NO. 333-100647

[PROSPECTUS GRAPHIC]

[SCANSOFT LOGO]

7,184,406 SHARES
COMMON STOCK
--------------------------------------------------------------------------------

We are selling 1,000,000 shares of common stock, and Lernout & Hauspie Speech
Products N.V., and L&H Holdings USA, Inc. (the selling stockholders), are
selling an additional 6,184,406 shares in this firm-commitment underwritten
offering. We will not receive any of the proceeds from the sale of the shares
sold by the selling stockholders. We have granted the underwriters a 30-day
option to purchase up to an additional 1,072,500 shares from us to cover
over-allotments, if any.

We are also filing, contemporaneously with the registration statement containing
this prospectus, a separate registration statement (file no. 333-100648)
pertaining to the registration on behalf of certain of our stockholders of an
additional 9,000,000 shares of our common stock. Each of these stockholders has
agreed not to offer, sell or otherwise dispose of any of these shares for a
period of 90 days after the date of this prospectus. We will not receive any
proceeds from the sale, if any, of the 9,000,000 shares registered under that
separate registration statement.

Our common stock is quoted on the Nasdaq National Market under the symbol
"SSFT." On February 10, 2003, the last reported sale price of our common stock
was $4.15 per share.
--------------------------------------------------------------------------------

INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 5.
--------------------------------------------------------------------------------

[Download Table]

PER SHARE TOTAL

Public offering price $3.8000 $27,300,742.80
Underwriting discount $0.2375 $ 1,706,296.42
Proceeds, before expenses, to us $3.5625 $ 3,562,500.00
Proceeds, before expenses, to the selling stockholders $3.5625 $22,031,946.38

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
--------------------------------------------------------------------------------
THOMAS WEISEL PARTNERS LLC
ADAMS, HARKNESS & HILL, INC.
INVESTEC INC.
The date of this prospectus is February 10, 2003.

424B1 2nd Page of 174 TOC 1st Previous Next ↓Bottom Just 2nd
TABLE OF CONTENTS

[Download Table]

PAGE
----

Prospectus Summary.......................................... 1
The Offering................................................ 3
Summary Consolidated Financial Data......................... 4
Risk Factors................................................ 5
Forward-Looking Statements.................................. 13
Trademarks and Other Information............................ 14
Use of Proceeds............................................. 14
Price Range of Common Stock................................. 15
Dividend Policy............................................. 15
Capitalization.............................................. 16
Dilution.................................................... 17
Selected Consolidated Financial Data........................ 18
Selected Quarterly Operating Results........................ 20
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 21
Business.................................................... 39
Management.................................................. 50
Certain Relationships and Securities Transactions........... 68
Principal and Selling Stockholders.......................... 70
Description of Capital Stock................................ 72
Shares Eligible for Future Sale............................. 76
Underwriting................................................ 77
Legal Matters............................................... 80
Experts..................................................... 80
Where You Can Find More Information......................... 80
Index to Financial Statements............................... F-1

424B1 3rd Page of 174 TOC 1st Previous Next ↓Bottom Just 3rd
PROSPECTUS SUMMARY

You should read the following summary together with the more detailed
information concerning our company, the common stock being sold in this offering
and our financial statements appearing in this prospectus. Because this is only
a summary, you should read the rest of this prospectus before you invest in our
common stock. Read this entire prospectus carefully, especially the risks
described under "Risk Factors."

SCANSOFT

We are a leading provider of software that allows users to incorporate
documents, images and speech into digital applications. Our products and
technologies automate manual processes and help enterprises, professionals and
consumers increase productivity, reduce costs and save time. Our products are
built upon digital capture and speech technologies, and are sold as solutions
into the financial, legal, healthcare, government, telecommunications and
automotive industries. Our digital capture technologies transform text and
images into digital form. Our speech technologies transform speech into text and
text into speech and permit voice control of applications. 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, sales and distribution channels and business
processes.

Our software is delivered as independent applications or as part of larger
integrated systems, such as systems for digital copiers on a network or customer
service call centers. Our digital capture solutions eliminate the need to
manually reproduce documents, automate the integration of documents into
business systems, and enable the use of electronic documents and forms within
XML, Internet, mobile and other business applications. Our speech solutions
automatically create documents from speech, transform text into synthesized
speech, and enable seamless interaction with hardware and software systems
simply by speaking. Our products and technologies deliver a measurable return on
investment to our customers.

Our extensive technology assets, intellectual property and industry
expertise in digital capture and speech create high barriers to entry in markets
where we compete. Our technologies are based on complex mathematical formulas,
which require large amounts of linguistic and image data, acoustic models and
recognition techniques. A significant investment in capital and time would be
necessary to replicate our current capabilities, and we continue to build upon
our leadership position. Our digital capture technology is recognized as the
most accurate in the industry, with rates as high as 99.8%, and supports more
than 100 languages. Our speech technology has industry-leading recognition
accuracy, provides natural sounding synthesized speech in 19 languages, and
supports a broad range of hardware platforms and operating systems. Our
technologies are covered by more than 300 patents or patent applications.

We have established relationships with more than 2,000 resellers, including
leading system vendors, independent software vendors, value-added resellers and
distributors, through which we market and distribute our products and solutions.
In digital capture, companies such as Brother, Canon, Hewlett-Packard, Visioneer
and Xerox include our technology in digital copiers, printers and scanners, as
well as multifunction devices that combine these capabilities. In addition,
companies such as Corel, Kofax, Lockheed Martin, Microsoft and Symantec embed
our digital capture technology into their commercial software applications. In
speech, companies such as Cisco, Dictaphone, Lucent, Matsushita and Microsoft
embed our technologies into telecommunications systems, as well as automotive,
PC or multimedia applications. Each of these listed companies is one of our five
largest revenue producing OEM customers, in their respective category, for the
nine months ended September 30, 2002. We also maintain an extensive network of
value-added resellers to address the needs of specific markets, such as
financial, legal, healthcare and government. We sell our applications to
enterprises, professionals and consumers through major independent distributors
that deliver our products to computer superstores, consumer electronic stores,
mail order houses, office superstores and eCommerce Web sites.

We sustained recurring losses from operations in each reporting period
through the first quarter of 2002 and we had an accumulated deficit of $151.4
million at September 30, 2002. We reported net income of $1.9 million and $2.8
million in the three months ended June 30, 2002 and September 30, 2002,
respectively, and $1.9 million for the nine months ended September 30, 2002.

424B1 4th Page of 174 TOC 1st Previous Next ↓Bottom Just 4th
RECENT DEVELOPMENTS

On October 31, 2002, we entered into a loan and security agreement with
Silicon Valley Bank for a revolving loan in a principal amount not to exceed $10
million, collateralized by substantially all of our personal property, but not
our intellectual property. At the date of this prospectus, no amounts have been
drawn under the terms of this agreement.

On January 3, 2003, in connection with a promissory note debt covenant
violation, we paid $3.3 million in full settlement of all principal and accrued
interest on the promissory note issued in connection with the L&H acquisition on
December 12, 2001. Additionally, on December 18, 2002, we issued 81,900 and
68,100 of our common stock to Lernout & Hauspie Speech Products N.V. and L&H
Holdings USA, Inc., respectively. These shares were issued in accordance with
the terms and conditions of the share repurchase agreement entered into with L&H
in September 2002.

Based on a preliminary review of our operating results for the fourth
quarter and full year 2002, we expect net revenue for the year ended December
31, 2002, to be approximately $106.5 million to $107.0 million. Additionally, we
expect our earnings before amortization of acquisition-related intangibles and
restructuring charges to be $0.25 per diluted share and, after including
amortization of acquisition-related intangibles and restructuring charges, we
expect our earnings to be approximately $0.08 per diluted share. By comparison,
for the full year 2001, we reported net revenue of $62.7 million with earnings
of $0.19 per diluted share, before amortization of acquisition-related
intangibles and a net loss of $0.34 per diluted share after including
amortization of acquisition-related intangibles. We expect to report our final
results for the fiscal year 2002 in mid-February.

We currently expect our revenue for the full-year 2003, including the
effect of the acquisition of the Philips Speech Processing business units, to be
approximately $135 to $140 million, an increase of more than 25 percent over
2002. We anticipate our 2003 earnings per diluted share, before amortization of
acquisition-related intangibles, to be $0.33 to $0.35, representing
approximately 35 percent growth. After including amortization of
acquisition-related intangibles, we expect our 2003 earnings per diluted share
to be $0.20 to $0.22. We expect this revenue and earnings growth to be weighted
toward the second half of 2003 as we complete the integration of the Philips
Speech Processing businesses.
---------------------

We maintain executive offices and principal facilities at 9 Centennial
Drive, Peabody, MA 01960. Our telephone number is (978) 977-2000. We maintain a
web site at www.ScanSoft.com.

---------------------

424B1 5th Page of 174 TOC 1st Previous Next ↓Bottom Just 5th
THE OFFERING

Common stock offered by us.............. 1,000,000 shares

Common stock offered by the selling
stockholders............................ 6,184,406 shares

Over-allotment option offered by us..... 1,072,500 shares

Common stock to be outstanding after
this offering........................... 64,422,776 shares

Use of proceeds......................... We do not have specific plans for
the use of the net proceeds to us
from this offering. We may use some
or all of the net proceeds to pay
amounts in connection with our
acquisition of certain business
units and related intellectual
property from Philips or future
acquisitions. We may also use some
of these funds for working capital
and capital expenditures. We will
not receive any proceeds from the
sale of common stock offered by the
selling stockholders.

Nasdaq National Market symbol........... SSFT

The foregoing information is based on 63,422,776 shares outstanding as of
December 31, 2002. This information does not include:

- 3,562,238 shares of Series B Preferred Stock that are convertible into
common stock on a one-to-one basis;

- 525,732 shares of common stock issuable upon exercise of outstanding
warrants at an exercise price of $0.61 per share;

- 15,145,707 shares of common stock issuable as of December 31, 2002 upon
exercise of outstanding stock options granted under our equity
compensation plans at a weighted average exercise price of $3.2037 per
share; and

- 2,882,397 shares of common stock reserved for future issuance as of
December 31, 2002 under our equity compensation plans.
---------------------

Except as otherwise indicated, the information in this prospectus assumes
no exercise of the underwriters' over-allotment option.

The selling stockholders are Lernout & Hauspie Speech Products N.V., and
L&H Holdings USA, Inc. Of the 6,184,406 shares being offered by the selling
stockholders under this prospectus, 4,122,300 are held of record by Lernout &
Hauspie and 2,062,106 are held of record by L&H Holdings. We issued the shares
of common stock being sold by the selling stockholders in this offering in
connection with our purchase of substantially all of the speech and language
operations of the selling stockholders.

424B1 6th Page of 174 TOC 1st Previous Next ↓Bottom Just 6th
SUMMARY CONSOLIDATED FINANCIAL DATA

The following table presents summary financial data for the five most
recent years, and the first nine months of the current year, comparative to the
same period in the prior year, which are derived from our consolidated financial
statements. Since the information in this table is only a summary and does not
provide all of the information contained in our financial statements, including
related notes, you should read "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and our consolidated financial
statements, including related notes, contained elsewhere in this prospectus.

[Enlarge/Download Table]

NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------------------- ------------------
1997 1998 1999 2000 2001 2001 2002
-------- ------- ------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue................................ $ 57,623 $79,070 $31,629 $ 49,055 $ 63,855 $ 44,130 $78,184
Income (loss) from operations................ (24,320) (3,858) (3,613) (52,497) (16,931) (14,545) 1,905
Income (loss) before income taxes............ (23,380) (3,805) (2,598) (52,779) (17,194) (14,671) 1,727
Net income (loss)............................ $(23,380) $(3,805) $(2,748) $(53,251) $(16,877) $(14,509) $ 1,893
======== ======= ======= ======== ======== ======== =======
Net income (loss) per share:
Basic and diluted............................ $ (1.20) $ (0.19) $ (0.11) $ (1.26) $ (0.34) $ (0.30) $ 0.03
======== ======= ======= ======== ======== ======== =======
Weighted average shares outstanding:
Basic...................................... 19,450 19,728 25,630 42,107 49,693 48,638 67,116
Diluted.................................... 19,450 19,728 25,630 42,107 49,693 48,638 72,451

[Enlarge/Download Table]

AS OF DECEMBER 31, AS OF
------------------------------------------------- SEPTEMBER 30,
1997 1998 1999 2000 2001 2002
------- ------- ------- -------- -------- -------------
(IN THOUSANDS)

CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments............................ $14,452 $ 8,123 $ 5,224 $ 2,633 $ 14,324 $ 14,382
Working capital (deficit)................ 8,389 6,569 7,031 (6,484) 9,318 15,765
Total assets............................. 33,550 28,445 29,982 109,480 142,070 139,270
Long-term liabilities.................... 125 91 -- 2,172 6,370 4,425
Total stockholders' equity............... 10,930 7,582 21,924 87,461 114,534 114,934

424B1 7th Page of 174 TOC 1st Previous Next ↓Bottom Just 7th
RISK FACTORS

You should carefully consider the risks described below before making a
decision to invest in our common stock. 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. The trading price of our common stock
could decline due to any of these risks, and you may lose all or part of your
investment. This prospectus contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks described below and elsewhere in this prospectus.

RISKS RELATING TO OUR BUSINESS

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;

- customers delaying their purchase decisions in anticipation of new
versions of products;

- 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 the first quarter of 2002 and we had an accumulated deficit of $151.4
million at September 30, 2002. We reported net income of approximately $1.9
million and $2.8 million in the quarters ended June 30, 2002 and September 30,
2002, respectively, and approximately $1.9 million for the nine months ended
September 30, 2002. If we do not maintain profitability, the market price for
our stock may decline, perhaps substantially.

424B1 8th Page of 174 TOC 1st Previous Next ↓Bottom Just 8th
OUR BUSINESS COULD BE HARMED IF WE DO NOT SUCCESSFULLY MANAGE THE INTEGRATION OF
THE BUSINESSES THAT WE ACQUIRE, INCLUDING OUR PURCHASE OF THE SPEECH PROCESSING
TELEPHONY AND VOICE CONTROL BUSINESS UNITS FROM PHILIPS.

As part of our business strategy, we have in the past and expect to
continue to acquire other businesses and technologies. Our recent 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) required substantial integration and management efforts. Our
purchase of the Speech Processing Telephony and Voice Control business units
from Philips will pose similar challenges. Acquisitions 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;

- difficulty in incorporating acquired technology and rights into our
products and technology;

- unanticipated expenses and delays in completing acquired development
projects and technology integration;

- management of geographically remote units both in the United States and
internationally;

- impairment of relationships with partners and customers;

- entering markets or types of businesses in which we have limited
experience; and

- potential loss of key employees of the acquired company.

As a result of these and other risks, we may not realize anticipated
benefits from our acquisitions. Any failure to achieve these benefits or failure
to successfully integrate acquired businesses and technologies could seriously
harm our business.

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 never be successfully implemented or marketed by our licensees.

OEM revenue represented 30% and 34% of our consolidated revenue for the
year ended December 31, 2001 and for the nine months ended September 30, 2002,
respectively. One of our partners, Xerox Corporation, accounted for 11% and 5%
of our consolidated revenue during the year ended December 31, 2001 and the nine
months ended September 30, 2002, respectively. Our partners are not required to
continue to bundle or embed our software, and they may choose the software
products of our competitors 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

424B1 9th Page of 174 TOC 1st Previous Next ↓Bottom Just 9th
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 made several significant acquisitions over the last two years, have
recently completed the purchase of certain businesses and intellectual property
from Philips 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 and the L&H acquisitions, we issued 19.0
million and 7.4 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 81% OF OUR REVENUE FOR THE YEAR ENDED DECEMBER
31, 2001 AND 49% FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002. ANY REDUCTION IN
REVENUE FROM THESE PRODUCT AREAS COULD SERIOUSLY HARM OUR BUSINESS.

Historically, a substantial portion of our revenue has been generated by a
few product areas. For the year ended December 31, 2001, our document and PDF
conversion products represented approximately 65% of our revenue, and our
digital paper management products represented approximately 16% of our revenue.
For the nine months ended September 30, 2002, our document and PDF conversion
products represented 38% of our revenue and our digital paper management
products represented 11% of our revenue. Although the relative share of our
revenue derived from these products decreased during 2002 due to the inclusion
of sales of our speech products after the L&H acquisition, a 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

424B1 10th Page of 174 TOC 1st Previous Next ↓Bottom Just 10th
we regard as proprietary. Policing unauthorized use of our products is difficult
and we may not be able to protect our technology from unauthorized use.
Additionally, our competitors may independently develop technologies that are
substantially the same or superior to ours. In addition, the laws of some
foreign countries do not protect our proprietary rights to the same extent as
the laws of the United States. Although the source code for our proprietary
software is protected both as a trade secret and as a copyrighted work,
litigation may be necessary to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation, regardless of the outcome, can be very expensive and can
divert management efforts.

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 any 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 November 27, 2002, AllVoice Computing plc filed an action against us in
the United States District Court for the Southern District of Texas claiming
patent infringement. In the lawsuit, AllVoice alleges that we are infringing
United States Patent No. 5,799,273 entitled "Automated Proofreading Using
Interface Linking Recognized Words to Their Audio Data While Text Is Being
Changed" (the "'273 Patent"). The '273 Patent generally discloses techniques for
manipulating audio data associated with text generated by a speech recognition
engine. Although we have several products in the speech recognition technology
field, we believe that these products do not infringe the '273 Patent because
our products do not use the claimed techniques. We believe this claim has no
merit, and we intend to defend the action vigorously.

In December 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 July 1, 2002. We
cannot predict the outcome of the claim, nor can we make any estimate of the
amount of damages, if any, for which we will be held responsible in the event of
a negative conclusion of the claim. 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 and our operating results
and financial position could be harmed.

424B1 11th Page of 174 TOC 1st Previous Next ↓Bottom Just 11th
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, Nuance Communications, Philips Electronics and SpeechWorks
International. 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 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. In particular,
during the year ended December 31, 2001, two distribution and fulfillment
partners, Ingram Micro and Digital River, accounted for 28% and 15% of our
consolidated
9

424B1 12th Page of 174 TOC 1st Previous Next ↓Bottom Just 12th
revenue, respectively. For the nine months ended September 30, 2002, Ingram
Micro and Digital River accounted for 26% and 12% 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, 2002, Ingram Micro, Tech Data and Digital River represented 19%,
8% and 17% of our net accounts receivable, respectively. At December 31, 2001,
Ingram Micro, Tech Data and Digital River represented 16%, 11% and 5%, 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 the year ended December 31, 2001 and
the nine months ended September 30, 2002, represented 21% and 26% of our
consolidated revenue for those periods, respectively. 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 28% and 31% of our consolidated revenue for the year ended
December 31, 2001 and the nine months ended September 30, 2002, respectively.

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.

424B1 13th Page of 174 TOC 1st Previous Next ↓Bottom Just 13th
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. 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.

424B1 14th Page of 174 TOC 1st Previous Next ↓Bottom Just 14th
RISKS RELATING TO THIS OFFERING

FUTURE SALES OF OUR COMMON STOCK BY CERTAIN OF OUR STOCKHOLDERS COULD CAUSE OUR
STOCK PRICE TO DECREASE.

Upon the effectiveness of this offering, the 7,184,406 shares registered
hereby will be freely tradable. Under a separate Registration Statement, we are
registering an additional 9,000,000 shares on behalf of certain of our
stockholders. Each of these stockholders has agreed that it will not offer, sell
or otherwise dispose of any of our securities with respect to which it has
registration rights, including the shares covered by that registration
statement, for a period of 90 days after the date of this prospectus. If these
stockholders subsequently sell substantial amounts of our common stock in the
public market, or if public investors believe that these stockholders are likely
subsequently to sell substantial amounts of our common stock in the near future,
the market price of our common stock could decrease.

THE STOCKHOLDINGS OF OUR TWO LARGEST STOCKHOLDERS MAY ENABLE THEM TO INFLUENCE
MATTERS REQUIRING STOCKHOLDER APPROVAL.

As of December 31, 2002, Xerox beneficially owned approximately 23.6% 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 18.5% of our common stock as of December 31,
2002. 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 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.

MANAGEMENT WILL HAVE BROAD DISCRETION OVER THE USE OF PROCEEDS FROM THIS
OFFERING.

We are not obligated to use the proceeds to us from this offering for any
particular purpose. Accordingly, our management will have considerable
discretion in the application of the net proceeds. We may use some or all of the
net proceeds from this offering to fund potential acquisitions, if and when they
become available; working capital; and capital expenditures. As disclosed in
this prospectus, under the terms of our acquisition of certain business units
and related intellectual property of Philips, we have agreed to pay 1.0 million
euros in cash prior to December 31, 2003 in connection with this acquisition.
Some or all of the proceeds of this offering may also be used for this purpose.
Although we investigate the acquisition of complementary businesses and
technologies on an ongoing basis, at the date of this prospectus we have no
commitments or agreements to acquire any such businesses or technologies.
Pending use of the net proceeds as discussed above, we intend to invest these
funds in short-term, interest-bearing, investment grade obligations.

424B1 15th Page of 174 TOC 1st Previous Next ↓Bottom Just 15th
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 classified board of directors;

- 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.

FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. These forward-looking
statements include predictions regarding:

- our revenue, earnings, cash flow and liquidity;

- our strategy relating to speech and language technologies;

- our expectations regarding our acquisition of certain business units and
related intellectual property 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;

- cost savings arising from our 2002 restructuring; and

- legal proceedings and litigation matters.

You can identify these and other forward-looking statements by the use of
words such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "intends," "potential," "continue" or the
negative of such terms, or other comparable terminology. Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.

Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth in this prospectus under the heading "Risk Factors." All forward-looking
statements included in this document are based on information available to us on
the date hereof. We assume no obligation to update any forward-looking
statements.

424B1 16th Page of 174 TOC 1st Previous Next ↓Bottom Just 16th
TRADEMARKS AND OTHER INFORMATION

You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of our common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock. In this prospectus, "ScanSoft,"
"we," "us," and "our" refer to ScanSoft, Inc., its predecessors and its
consolidated subsidiaries.

ScanSoft(R), Dragon NaturallySpeaking(R), OmniForm(R), OmniPage(R),
TextBridge(R), Pagis(R), PaperPort(R) and PaperPort Deluxe(R) are registered
trademarks of ScanSoft, Inc. RealSpeak(TM), AudioMining(TM), MediaIndexer(TM),
Capture Development System(TM) and PaperPortOnline(TM) are trademarks of
ScanSoft, Inc. Each trademark, trade name, or service mark of any other company
appearing in this prospectus belongs to its holder.

Information contained on our web site or any other web sites identified in
this prospectus is not part of this prospectus. All Web site addresses listed in
this prospectus are intended to be inactive, textual references only.

USE OF PROCEEDS

We estimate that we will receive net proceeds from the sale of shares of
our common stock in this offering of approximately $2.1 million, or $5.9 million
if the underwriters exercise their over-allotment option in full, based upon the
public offering price of $3.80 per share and after deducting estimated
underwriting discounts and offering expenses payable by us. We do not have
specific plans for the use of the net proceeds to us of this offering. However,
we may use some or all of the net proceeds from this offering to fund potential
acquisitions, if and when they become available; working capital; and capital
expenditures. As disclosed in this prospectus, under the terms of our
acquisition agreement with Philips, we have agreed to pay 1.0 million euros in
cash prior to December 31, 2003 in connection with this acquisition. Some or all
of the proceeds of this offering may also be used for this purpose. Although we
investigate the acquisition of complementary businesses and technologies on an
ongoing basis, at the date of this prospectus we have no commitments or
agreements to acquire any such businesses or technologies. Pending use of the
net proceeds as discussed above, we intend to invest these funds in short-term,
interest-bearing, investment grade obligations.

We will not receive any proceeds from the sale of common stock offered by
the selling stockholder.

424B1 17th Page of 174 TOC 1st Previous Next ↓Bottom Just 17th
PRICE RANGE OF COMMON STOCK

Our common stock commenced trading on the Nasdaq National Market on
December 11, 1995 under the symbol "VSNR," and traded under that symbol until
March 3, 1999. Our common stock is now traded under the symbol "SSFT." As of
December 31, 2002, there were outstanding approximately 63,422,776 shares of
common stock held by 566 stockholders of record. The following table sets forth
for the periods indicated the high and low sale prices for our common stock as
reported on the Nasdaq National Market.

[Download Table]

HIGH LOW
----- -----

FISCAL 2003:
First Quarter (through February 10, 2003)................. $6.50 $4.10
FISCAL 2002:
First Quarter............................................. $6.00 $2.88
Second Quarter............................................ 8.85 5.30
Third Quarter............................................. 7.94 3.15
Fourth Quarter............................................ 7.77 3.16
FISCAL 2001:
First Quarter............................................. $1.69 $0.66
Second Quarter............................................ 1.69 0.50
Third Quarter............................................. 1.68 1.20
Fourth Quarter............................................ 5.50 1.35
FISCAL 2000:
First Quarter............................................. $6.81 $3.72
Second Quarter............................................ 5.00 2.22
Third Quarter............................................. 2.81 1.28
Fourth Quarter............................................ 1.75 0.41

The last reported sale price of our common stock on the Nasdaq National
Market on February 10, 2003 was $4.15.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We
currently expect to retain future earnings, if any, to finance the growth and
development of our business and do not anticipate paying any cash dividends in
the foreseeable future.

424B1 18th Page of 174 TOC 1st Previous Next ↓Bottom Just 18th
CAPITALIZATION

The following table sets forth our cash, cash equivalents and
capitalization as of September 30, 2002:

- on an actual basis, and

- as adjusted to reflect the sale by us of 1,000,000 shares of our common
stock at the public offering price of $3.80 per share, less underwriting
discounts and commissions and estimated offering expenses.

This information should be read in conjunction with Management's Discussion
and Analysis of Financial Condition and Results of Operations and our financial
statements and notes to those statements appearing elsewhere in this prospectus.

[Enlarge/Download Table]

AS OF SEPTEMBER 30, 2002
---------------------------
ACTUAL AS ADJUSTED
----------- -------------
(IN THOUSANDS, EXCEPT SHARE
DATA)

Cash and cash equivalents................................... $ 14,382 $ 16,506
========= =========
Note payable................................................ 3,328 3,328
--------- ---------
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; 65,334,366 issued and 63,216,988
outstanding, actual; and 66,334,366 issued and
64,216,988 outstanding, as adjusted.................... 65 66
Additional paid-in capital................................ 269,822 271,945
Treasury stock at cost (2,117,378 shares)................. (8,031) (8,031)
Deferred compensation..................................... (199) (199)
Accumulated other comprehensive income.................... 12 12
Accumulated deficit....................................... (151,366) (151,366)
--------- ---------
Total stockholders' equity............................. 114,934 117,058
--------- ---------
Total capitalization................................. $ 118,262 $ 120,386
========= =========

On January 3, 2003, in connection with a promissory note debt covenant
violation, we paid $3.3 million in full settlement of all principal and accrued
interest on the promissory note issued in connection with the L&H acquisition on
December 12, 2001. This reduced our "Note Payable" set forth above to $0, and
was paid out of existing cash on hand. Additionally, on December 18, 2002, we
issued 81,900 and 68,100 of its common stock to Lernout & Hauspie Speech
Products N.V. and L&H Holdings USA, Inc., respectively. These shares were issued
in accordance with the terms and conditions of the share repurchase agreement
entered into with L&H in September 2002. Please see pages F-46 and F-87 for
further information relating to these agreements.

424B1 19th Page of 174 TOC 1st Previous Next ↓Bottom Just 19th
DILUTION

If you invest in our common stock your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the net tangible book value per share of our common stock after
this offering.

Our net tangible book value on September 30, 2002 was $15.6 million or
$0.25 per share of common stock. Net tangible book value per share is determined
by dividing the number of outstanding shares of our common stock into our net
tangible book value, which is our total tangible assets less our total
liabilities. Dilution in net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of our
common stock in this offering and the net tangible book value per share of our
common stock immediately after completion of this offering. After giving effect
to our sale of 1.0 million shares of common stock offered by this prospectus at
the public offering price of $3.80 per share and after deducting the
underwriting discounts, commissions and estimated offering expenses payable by
us, our net tangible book value would have been approximately $17.7 million, or
$0.28 per share. This represents an immediate increase in net tangible book
value of $0.03 per share to existing stockholders and an immediate dilution in
net tangible book value of $3.52 per share to new investors. The following table
illustrates the per share dilution:

[Download Table]

Estimated public offering price per share................... $3.80
Net tangible book value per share as of September 30,
2002................................................... $0.25
Increase per share attributable to new investors.......... 0.03
-----
Net tangible book value per share after this offering....... 0.28
-----
Dilution in net tangible book value per share to new
investors................................................. $3.52
=====

424B1 20th Page of 174 TOC 1st Previous Next ↓Bottom Just 20th
SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data is not necessarily
indicative of the results of future operations and should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes included
elsewhere in this prospectus.

The statement of operations data for the years ended December 31, 2001,
2000 and 1999 and the balance sheet data as of December 31, 2001 and 2000 have
been derived from our consolidated financial statements audited by
PricewaterhouseCoopers LLP, independent accountants, included elsewhere in this
prospectus. The statement of operations data for the years ended December 31,
1998 and 1997 have been derived from our consolidated financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, which are not
included elsewhere in this prospectus. The statement of operations data for the
nine months ended September 30, 2002 and 2001 and the balance sheet data as of
September 30, 2002 have been derived from our unaudited consolidated financial
statements included elsewhere in this prospectus.

On March 2, 1999, we acquired ScanSoft, Inc., an indirect wholly-owned
subsidiary of Xerox Corporation. On June 30, 1999, we acquired certain assets
and liabilities of MetaCreations Corporation. On March 13, 2000, we acquired
Caere. On December 12, 2001, we acquired substantially all of the speech and
language technology operations of L&H. These acquisitions were each accounted
for under the purchase method of accounting. Accordingly, the results of
operations from the ScanSoft, MetaCreations, Caere and L&H acquisitions are
included in our results of operations from the applicable acquisition dates.

Through December 1998, we developed and sold scanner hardware and software
products. On January 6, 1999, we sold our hardware business. Accordingly, the
results of the hardware business are included in our results of operations
through the date of disposal.

[Enlarge/Download Table]

NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------------------- ------------------
1997 1998 1999 2000 2001 2001 2002
-------- ------- ------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Total revenue................... $ 57,623 $79,070 $31,629 $ 49,055(5) $ 63,855(5) $ 44,130 $78,184
-------- ------- ------- -------- -------- -------- -------
Costs and expenses:
Cost of revenue............... 50,725 59,370 7,602 12,692 12,849 9,215 12,937
Cost of revenue from
amortization of intangible
assets...................... -- -- 1,405 11,569 14,192 10,536 7,494
Research and development...... 8,115 4,408 6,920 14,967 13,968 10,016 21,310
Selling, general and
administrative.............. 22,428 19,150 14,509 28,205 26,449 18,944 32,051
Amortization of goodwill and
other intangible
assets(1)................... -- -- 516 11,017 13,328 9,964 1,446
Restructuring and other
charges, net(2)(3).......... 675 -- 346 4,811 -- -- 1,041
Acquired in-process research
and development(4).......... -- -- 3,944 18,291 -- -- --
-------- ------- ------- -------- -------- -------- -------
Total costs and expenses.... 81,943 82,928 35,242 101,552 80,786 58,675 76,279
-------- ------- ------- -------- -------- -------- -------
Income (loss) from operations... (24,320) (3,858) (3,613) (52,497) (16,931) (14,545) 1,905
Other income (expense), net..... 940 53 1,015 (282) (263) (126) (178)
-------- ------- ------- -------- -------- -------- -------
Income (loss) before income
taxes......................... (23,380) (3,805) (2,598) (52,779) (17,194) (14,671) 1,727
Provision for (benefit from)
income taxes.................. -- -- 150 472 (317) (162) (166)
-------- ------- ------- -------- -------- -------- -------
Net income (loss)............... $(23,380) $(3,805) $(2,748) $(53,251) $(16,877) $(14,509) $ 1,893
======== ======= ======= ======== ======== ======== =======
Net income (loss) per share:
basic and diluted............. $ (1.20) $ (0.19) $ (0.11) $ (1.26) $ (0.34) $ (0.30) $ 0.03
======== ======= ======= ======== ======== ======== =======
Weighted average common shares
outstanding:
Basic......................... 19,450 19,728 25,630 42,107 49,693 48,638 67,116
======== ======= ======= ======== ======== ======== =======
Diluted....................... 19,450 19,728 25,630 42,107 49,693 48,638 72,451
======== ======= ======= ======== ======== ======== =======

424B1 21st Page of 174 TOC 1st Previous Next ↓Bottom Just 21st
[Enlarge/Download Table]

AS OF DECEMBER 31, AS OF
------------------------------------------------- SEPTEMBER
1997 1998 1999 2000 2001 30, 2002
------- ------- ------- -------- -------- ---------
(IN THOUSANDS)

CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.............................. $14,452 $ 8,123 $ 5,224 $ 2,633 $ 14,324 $ 14,382
Working capital (deficit).................. 8,389 6,569 7,031 (6,484) 9,318 15,765
Total assets............................... 33,550 28,445 29,982 109,480 142,070 139,270
Long-term liabilities...................... 125 91 -- 2,172 6,370 4,425
Total stockholders' equity................. 10,930 7,582 21,924 87,461 114,534 114,934

---------------

(1) See Note 4 to Notes to Unaudited Consolidated Financial Statements.

(2) See Note 12 to Notes to Consolidated Financial Statements.

(3) See Note 6 to Notes to Unaudited Consolidated Financial Statements.

(4) See Note 11 to Notes to Consolidated Financial Statements.

(5) Excludes the impact of EITF 01-9 which was adopted on January 1, 2002. See
Note 2 to Unaudited Consolidated Financial Statements. If EITF 01-9 had been
implemented and applied to the years 2000 and 2001, our total revenue would
have been $48.0 million and $62.7 million, respectively.

424B1 22nd Page of 174 TOC 1st Previous Next ↓Bottom Just 22nd
SELECTED QUARTERLY OPERATING RESULTS

The following table sets forth unaudited quarterly consolidated statement
of operations data for the eleven quarters ended September 30, 2002 as well as
the percentage of total revenue represented by each item. The information for
each of these quarters has been prepared on substantially the same basis as the
audited financial statements included elsewhere in this prospectus, and, in the
opinion of management, includes all adjustments, consisting only of normal
recurring adjustments, necessary for the fair presentation of the results of
operations for such periods. This quarterly information reflects the adoption of
EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor's Products), as described in Note 2 to the
Notes to the Unaudited Consolidated Financial Statements. This data should be
read in conjunction with the consolidated financial statements and the related
notes included elsewhere in this prospectus. These quarterly operating results
are not necessarily indicative of the operating results for the full year ending
December 31, 2002 or any future period.

[Enlarge/Download Table]

QUARTER ENDED
----------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
2000 2000 2000 2000 2001 2001 2001
-------- -------- --------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue(2)............................... $ 7,166 $ 13,817 $13,259 $13,719 $12,501 $14,864 $16,765
Costs and expenses:
Cost of revenue............................... 2,441 4,084 2,962 3,205 2,890 2,828 3,497
Cost of revenue from amortization of
intangible assets........................... 1,081 3,496 3,496 3,496 3,512 3,512 3,512
Research and development...................... 3,235 4,820 3,830 3,082 3,197 3,238 3,581
Selling, general and administrative........... 5,188 8,614 6,463 6,846 6,286 6,113 6,545
Amortization of goodwill and other intangible
assets(3)................................... 833 3,602 3,291 3,291 3,322 3,321 3,321
Restructuring and other charges, net(4)(5).... -- 4,956 -- (145) -- -- --
Acquired in-process research and
development(6).............................. 18,291 -- -- -- -- -- --
-------- -------- ------- ------- ------- ------- -------
Total costs and expenses....................... 31,069 29,572 20,042 19,775 19,207 19,012 20,456
-------- -------- ------- ------- ------- ------- -------
Income (loss) from operations.................. (23,903) (15,755) (6,783) (6,056) (6,706) (4,148) (3,691)
Other income (expense), net.................... 35 (35) (257) (25) (133) (5) 12
-------- -------- ------- ------- ------- ------- -------
Income (loss) before income taxes.............. (23,868) (15,790) (7,040) (6,081) (6,839) (4,153) (3,679)
Provision for (benefit from) income taxes...... 70 238 36 128 61 242 (465)
-------- -------- ------- ------- ------- ------- -------
Net income (loss).............................. $(23,938) $(16,028) $(7,076) $(6,209) $(6,900) $(4,395) $(3,214)
======== ======== ======= ======= ======= ======= =======
Net income (loss) per share:
Basic......................................... $ (0.78) $ (0.35) $ (0.15) $ (0.13) $ (0.15) $ (0.09) $ (0.06)
======== ======== ======= ======= ======= ======= =======
Diluted....................................... $ (0.78) $ (0.35) $ (0.15) $ (0.13) $ (0.15) $ (0.09) $ (0.06)
======== ======== ======= ======= ======= ======= =======
Weighted average common shares outstanding:
Basic......................................... 30,529 45,918 45,963 46,032 46,100 48,939 50,875
======== ======== ======= ======= ======= ======= =======
Diluted....................................... 30,529 45,918 45,963 46,032 46,100 48,939 50,875
======== ======== ======= ======= ======= ======= =======
AS A PERCENTAGE OF TOTAL REVENUE:
Total revenue.................................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue............................... 34.1 29.5 22.4 23.3 23.0 19.1 20.9
Cost of revenue from amortization of
intangible assets........................... 15.1 25.3 26.4 25.5 28.0 23.6 20.9
Research and development...................... 45.1 34.9 28.9 22.5 25.5 21.9 21.4
Selling, general and administrative........... 72.4 62.3 48.7 50.0 50.1 41.1 39.0
Amortization of goodwill and other intangible
assets...................................... 11.6 26.1 24.8 24.0 26.5 22.3 19.8
Restructuring and other charges, net.......... -- 35.9 -- (1.1) -- -- --
Acquired in-process research and
development................................. 255.2 -- -- -- -- -- --
-------- -------- ------- ------- ------- ------- -------
Total costs and expenses....................... 433.5 214.0 151.2 144.2 153.1 128.0 122.0
-------- -------- ------- ------- ------- ------- -------
Income (loss) from operations.................. (333.5) (114.0) (51.2) (44.2) (53.1) (28.0) (22.0)
Other income (expense), net.................... 0.5 (0.3) (1.9) (0.2) (1.1) (0.0) 0.1
-------- -------- ------- ------- ------- ------- -------
Income (loss) before income taxes.............. (333.0) (114.3) (53.1) (44.4) (54.2) (28.0) (21.9)
Provision for (benefit from) income taxes...... 1.0 1.7 0.3 0.9 1.0 1.6 (2.7)
-------- -------- ------- ------- ------- ------- -------
Net income (loss).............................. (334.0%) (116.0%) (53.4%) (45.3%) (55.2%) (29.6%) (19.2%)
======== ======== ======= ======= ======= ======= =======

QUARTER ENDED
---------------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
2001 2002 2002 2002
-------- ----------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
AS
RESTATED(1)

CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue(2)............................... $18,587 $23,765 $26,184 $28,235
Costs and expenses:
Cost of revenue............................... 3,634 4,129 4,609 4,199
Cost of revenue from amortization of
intangible assets........................... 3,656 3,542 1,976 1,976
Research and development...................... 3,952 6,986 7,067 7,257
Selling, general and administrative........... 6,367 9,711 10,928 11,412
Amortization of goodwill and other intangible
assets(3)................................... 3,364 957 253 236
Restructuring and other charges, net(4)(5).... -- 1,041 -- --
Acquired in-process research and
development(6).............................. -- -- -- --
------- ------- ------- -------
Total costs and expenses....................... 20,973 26,366 24,833 25,080
------- ------- ------- -------
Income (loss) from operations.................. (2,386) (2,601) 1,351 3,155
Other income (expense), net.................... (137) (75) 65 (168)
------- ------- ------- -------
Income (loss) before income taxes.............. (2,523) (2,676) 1,416 2,987
Provision for (benefit from) income taxes...... (155) 206 (534) 162
------- ------- ------- -------
Net income (loss).............................. $(2,368) $(2,882) $ 1,950 $ 2,825
======= ======= ======= =======
Net income (loss) per share:
Basic......................................... $ (0.04) $ (0.05) $ 0.03 $ 0.04
======= ======= ======= =======
Diluted....................................... $ (0.04) $ (0.05) $ 0.03 $ 0.04
======= ======= ======= =======
Weighted average common shares outstanding:
Basic......................................... 52,858 62,304 67,595 67,865
======= ======= ======= =======
Diluted....................................... 52,858 62,304 76,677 74,787
======= ======= ======= =======
AS A PERCENTAGE OF TOTAL REVENUE:
Total revenue.................................. 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue............................... 19.5 17.4 17.6 14.9
Cost of revenue from amortization of
intangible assets........................... 19.5 14.9 7.5 7.0
Research and development...................... 21.1 29.3 27.0 25.7
Selling, general and administrative........... 34.3 40.9 41.7 40.4
Amortization of goodwill and other intangible
assets...................................... 18.1 4.0 1.0 0.8
Restructuring and other charges, net.......... -- 4.4 -- --
Acquired in-process research and
development................................. -- -- -- --
------- ------- ------- -------
Total costs and expenses....................... 112.5 110.9 94.8 88.8
------- ------- ------- -------
Income (loss) from operations.................. (12.5) (10.9) 5.2 11.2
Other income (expense), net.................... (0.7) (0.3) 0.2 (0.6)
------- ------- ------- -------
Income (loss) before income taxes.............. (13.2) (11.2) 5.4 10.6
Provision for (benefit from) income taxes...... (0.8) 0.9 (2.0) 0.6
------- ------- ------- -------
Net income (loss).............................. (12.4%) (12.1%) 7.4% 10.0%
======= ======= ======= =======

---------------

(1) See Note 1 to Notes to Unaudited Consolidated Financial Statements.

(2) See Note 1 to Notes to Unaudited Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.

(3) See Note 4 to Notes to Unaudited Consolidated Financial Statements.

(4) See Note 12 to Notes to Consolidated Financial Statements.

(5) See Note 6 to Notes to Unaudited Consolidated Financial Statements.

(6) See Note 11 to Notes to Consolidated Financial Statements.

424B1 23rd Page of 174 TOC 1st Previous Next ↓Bottom Just 23rd
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes thereto included elsewhere in the prospectus. This
discussion contains forward-looking statements, which involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements for many reasons, including the risks
described in "Risk Factors" starting on page 5 and elsewhere in this prospectus.

OVERVIEW

We are a leading provider of software that allows users to incorporate
documents, images and speech into digital applications. Our products and
technologies automate manual processes and help enterprises, professionals and
consumers increase productivity, reduce costs and save time. Our products are
built upon digital capture and speech technologies, and are sold as solutions
into the financial, legal, healthcare, government, telecommunications and
automotive 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.

On December 12, 2001, we acquired substantially all of the speech and
language technologies operations of L&H. Consideration for the transaction
comprised $10 million in cash, a $3.5 million note and 7.4 million shares of our
common stock having a value of $27.8 million. The operations acquired include
text-to-speech, speech recognition and dictation, and voice control
technologies.

On January 30, 2003, we completed the acquisition of the Speech Processing
Telephony and Voice Control business units of Royal Philips Electronics, and
related intellectual property on the terms set forth in the purchase agreement
dated October 7, 2002, as amended. The Telephony business unit offers speech-
enabled services including directory assistance, interactive voice response and
voice portal applications for enterprise customers, telephony venders 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 these
business units and intellectual property, 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. The technology acquired
includes several speech recognition and voice control products.

As of October 31, 2002, we entered into a loan and security agreement with
Silicon Valley Bank for a revolving loan in a principal amount not to exceed $10
million, collateralized by substantially all of our personal property, but not
our intellectual property. At the date of this prospectus, no amounts have been
drawn under the terms of this agreement.

424B1 24th Page of 174 TOC 1st Previous Next ↓Bottom Just 24th
RESULTS OF OPERATIONS

The following table presents, as a percentage of total revenue, certain
selected financial data for each of the three years in the period ended December
31 and the nine months ended September 30, 2001 and 2002:

[Enlarge/Download Table]

NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1999 2000 2001 2001 2002
----- ------ ----- ----- -----

Total revenue...................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue.................................. 24.0 25.9 20.1 20.9 16.6
Cost of revenue from amortization of intangible
assets........................................ 4.4 23.6 22.2 23.9 9.6
Research and development......................... 21.9 30.5 21.9 22.7 27.3
Selling, general and administrative.............. 45.9 57.4 41.4 42.9 41.0
Amortization of goodwill and other intangible
assets(1)..................................... 1.6 22.5 20.9 22.6 1.8
Restructuring and other charges, net(2)(3)....... 1.1 9.8 -- -- 1.3
Acquired in-process research and
development(4)................................ 12.5 37.3 -- -- --
----- ------ ----- ----- -----
Total costs and expenses........................... 111.4 207.0 126.5 133.0 97.6
----- ------ ----- ----- -----
Income (loss) from operations...................... (11.4) (107.0) (26.5) (33.0) 2.4
Other income (expense), net........................ 3.2 (0.6) (0.4) (0.3) (0.2)
----- ------ ----- ----- -----
Income (loss) before income taxes.................. (8.2) (107.6) (26.9) (33.3) 2.2
Provision for (benefit from) for income taxes...... 0.5 1.0 (0.5) (0.4) (0.2)
----- ------ ----- ----- -----
Net income (loss).................................. (8.7%) (108.6%) (26.4%) (32.9%) 2.4%
===== ====== ===== ===== =====

---------------

(1) See Note 4 of Notes to Unaudited Consolidated Financial Statements.

(2) See Note 12 of Notes to Consolidated Financial Statements.

(3) See Note 6 of Notes to Unaudited Consolidated Financial Statements.

(4) See Note 11 of Notes to Consolidated Financial Statements.

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
services, primarily maintenance associated with software license transactions.

Sales of our software products through 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 revenue from sales to distributors
and resellers only when products have been sold by the distributors or resellers
to retailers or 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 inventory 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 were to 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. We make
estimates of the uncollectibility of our accounts receivable. We specifically
analyze accounts receivable and analyze

424B1 25th Page of 174 TOC 1st Previous Next ↓Bottom Just 25th
historical bad debts, customer concentrations, customer credit-worthiness,
current economic trends and changes in our customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts.

Royalty revenue derived from sales to OEM partners is recognized when
software copies are deployed and payment is due. Royalty revenue from OEM
customers with whom we have significant past experience is recognized based on
estimated deployments in the respective period. Differences between estimates
and actual deployments are recorded as an adjustment to revenue in the following
quarter. These estimates have been based on timely, informal communications with
the OEMs and the past payment and royalty reporting history of the OEMs,
seasonality of the OEM's business, the number of copies deployed in prior
periods and the overall economic climate in which the OEMs operate.

For the quarters ended June 30, 2001, March 31, 2002 and June 30, 2002,
differences between the actual and estimated deployments resulted in differences
between reported and actual revenue of ($0.5) million, ($0.3) million and $0.3
million, respectively, with a corresponding impact on operating and net
income/(loss) for such periods. We deemed that these differences would not have
a material impact on the results of operations for the years ending December 31,
2001 and December 31, 2002, respectively.

We believe that we can more accurately determine OEM revenue based on
reports of actual deployments received from OEM customers. While historically we
have been unable to obtain OEM deployment reports prior to reporting financial
results, we now believe we are in a position to obtain such reports on a timely
basis. Therefore, beginning with the fourth quarter of 2002, we intend to report
OEM revenue based on actual deployments as reported by OEM customers. We do not
expect this change will have a material effect on our financial position,
results of operations or cash flows.

Cost of revenue consists primarily of material and fulfillment costs,
third-party royalties, salaries for product support personnel, and engineering
costs associated with certain contracts which are accounted for under the
percentage of completion method of accounting. Currently, most of our software
products are manufactured, packaged and shipped by GlobalWare Solutions on a
worldwide basis. We believe that, if necessary, we could transition the services
provided by GlobalWare to another third party provider with minimal disruption
to our operations.

Cost of revenue from amortization of intangible assets includes the
amortization of acquired patents and core and completed technology.

Research and development expense consists primarily of salary and benefits
costs of engineers. We believe that the development of new products and the
enhancement of existing products are essential to our success. Accordingly, we
plan to continue to invest in research and development activities. To date, we
have not capitalized any internal development costs as the cost incurred after
technological feasibility but before release of product has not been
significant.

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 expense;
however, if revenue continues to grow, we expect selling, general and
administrative expense 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 goodwill and 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.

424B1 26th Page of 174 TOC 1st Previous Next ↓Bottom Just 26th
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO SEPTEMBER 30, 2001

Total Revenue

Total revenue for the nine months ended September 30, 2002 increased by
$34.1 million or 77% from the comparable period in 2001. The growth in revenue
for the nine months ended September 30, 2002 was primarily the result of revenue
generated from our speech products. Revenue from our speech products was $32.3
million and zero for the nine months ended September 30, 2002 and 2001,
respectively. The increase in speech revenue was due to the L&H acquisition,
which occurred in December 2001. Revenue from our digital capture products was
$45.9 million and $44.1 million for the nine months ended September 30, 2002 and
2001, respectively. The increase of $1.8 million in revenue from our digital
capture products from the comparable period in 2001 was due primarily to an
increase of $3.6 million in sales of Digital Capture Products through the
channel network, partially offset by a decrease in revenue of $1.8 million from
Xerox, a related party, due to the cancellation of its retail multi-function
product line in late 2001.

Geographic revenue classification is based on the country in which the sale
is invoiced. Revenue for the nine months ended September 30, 2002 was 74% North
America and 26% international, versus 79% North America and 21% international
for the comparable period in 2001.

A number of our OEM partners distribute their products throughout the world
and do not provide us with the geographical dispersion of their products. We
believe that, if we were 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 nine months ended
September 30, 2002 is approximately 69% North America and 31% international
versus 72% North America and 28% international for the comparable period in
2001. The increase in our international revenue percentage for the nine months
ended September 30, 2002 is driven primarily from Europe and Asia and is the
result of increased sales and marketing efforts and additional resellers.

The following table presents the breakdown of our total revenue for the
nine months ended September 30, 2001 and 2002:

[Download Table]

NINE MONTHS
ENDED
SEPTEMBER 30,
-------------
2001 2002
----- -----

VAR/retail.................................................. 48% 43%
Direct...................................................... 22% 23%
OEM......................................................... 30% 34%

The increase in OEM, and the corresponding decrease in VAR/retail, as a percent
of revenue, for the nine months ended September 30, 2002 as compared to the
corresponding period in 2001 was due to the addition of speech products in 2002.
OEMs represent a higher percentage of revenue for our speech products than for
our digital capture products.

Cost of Revenue

Cost of revenue for the nine months ended September 30, 2002 was $12.9
million or 16.6% of revenue, compared to $9.2 million or 20.9% for the same
period in 2001. The increase in cost of revenue in absolute dollars for the nine
months ended September 30, 2002 is directly attributable to the increase in the
volume of product sales to VAR/retail customers as well as increased embedded
text-to-speech revenue which bears a higher cost of revenue than our traditional
software products. The decrease in cost of revenue as a percentage of total
revenue for the nine months ended September 30, 2002, as compared to the same
period in 2001, is due to lower supply chain logistics and fulfillment costs,
partially offset by the higher cost of embedded text-to-speech revenue.

424B1 27th Page of 174 TOC 1st Previous Next ↓Bottom Just 27th
Cost of Revenue from Amortization of Intangible Assets

Cost of revenue from amortization of intangible assets for the nine months
ended September 30, 2002 was $7.5 million compared to $10.5 million for the
comparable period in 2001. The decrease in cost of revenue from amortization of
intangible assets of $3.0 million was due to $4.4 million of intangible assets
that became fully amortized in the first quarter of 2002. This reduction was
partially offset by $1.4 million of amortization recorded for the acquired L&H
assets.

Research and Development Expense

Research and development costs for the nine months ended September 30, 2002
were $21.3 million or 27.3% of total revenue, compared to $10.0 million or 22.7%
of total revenue for the comparable period in 2001. The increase in research and
development expenses of $11.3 million for the nine months ended September 30,
2002 is primarily the result of increased headcount of 138 employees associated
with the L&H acquisition. Cost savings from the restructuring actions taken in
2002 for the nine months ended September 30, 2002 was approximately $0.4
million.

Selling, General and Administrative Expense

Selling, general and administrative expense for the nine months ended
September 30, 2002 was $32.1 million or 41.0% of total revenue, compared to
$18.9 million or 42.9% for the same period in 2001. The increase in selling,
general and administrative expense in absolute dollars for the nine months ended
September 30, 2002 is primarily the result of increased headcount costs of $7.4
million resulting from the addition of 74 employees, primarily in sales and
marketing, as well as $2.3 million of increased marketing programs in support of
the higher revenue. These increases were largely attributable to the L&H
acquisition and expanded focus on international sales and marketing. The
decrease in selling, general and administrative expenses as a percentage of
total revenue for the nine months ended September 30, 2002 is the result of
synergies associated with the L&H acquisition, focused market spending and
revenue growth.

Amortization of Goodwill and Other Intangible Assets

Amortization of goodwill and other intangible assets for the nine months
ended September 30, 2002 was $1.4 million compared to $10.0 million for the
comparable period in 2001. The decrease in amortization expense is directly
attributable to the adoption of SFAS 142, as a result of which we ceased the
amortization of goodwill and acquired workforce of approximately $2.6 million
per quarter. Additionally, amortization expense decreased $1.0 million in the
nine months ended September 30, 2002, due to intangible assets that became fully
amortized in the first quarter of 2002. This reduction was partially offset by
additional amortization of approximately $0.2 million for the nine months ended
September 30, 2002 from the L&H acquisition.

Restructuring and Other Charges, Net

In January 2002, we announced, and in March 2002 completed, a restructuring
plan to consolidate facilities, worldwide sales organizations, research and
development teams and other personnel following the L&H acquisition on December
12, 2001. As a result, we exited certain 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, we recorded a restructuring charge in the amount of $0.6
million for severance payments to these employees and a 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.

During the nine months ended September 30, 2002, we paid a total of $0.7
million in severance payments, of which $0.6 million related to the March 2002
restructuring and $0.1 million related to severance paid to the former Caere
President and CEO, pursuant to a 2000 restructuring.

424B1 28th Page of 174 TOC 1st Previous Next ↓Bottom Just 28th
At September 30, 2002, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.7 million. This balance is
comprised of $0.2 million of lease exit costs resulting from the 2002
restructuring and $0.5 million of severance to the former Caere President and
CEO. The severance due to the former Caere President and CEO will be paid
through March 2005.

We anticipate that the 2002 restructuring action will provide future cost
savings of approximately $0.4 million for the remaining three months of 2002, of
which $0.3 million relates to employee-related costs and $0.1 million relates to
lease costs.

Income (Loss) from Operations

As a result of the above factors, income from operations was $1.9 million
in the nine months ended September 30, 2002 compared with a loss of ($14.5)
million in the comparable period in 2001.

Other Income (Expense), Net

Other income (expense), net was ($0.2) million for the nine months ended
September 30, 2002 compared to ($0.1) million for the same period in 2001. The
change in other income (expense), net for the nine months ended September 30,
2002 from the comparable period of 2001 is the result of an increase in interest
expense of $0.1 million and a decrease in other income of $0.1 million, offset
by an increase in interest income of $0.1 million, which was earned on an IRS
tax refund received in the second quarter of 2002.

Income (Loss) Before Income Taxes

Income before income taxes was $1.7 million in the nine months ended
September 30, 2002, compared with a loss of ($14.7) million in the comparable
period in 2001.

Income Taxes

The (benefit from) income taxes of ($0.2) million for the nine months ended
September 30, 2002 consisted of foreign and state tax provisions of $0.7
million, 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. The (benefit
from) income taxes of ($0.2) million for the nine months ended September 30,
2001 consisted of foreign and state tax provisions of $0.5 million offset by the
state tax benefit of ($0.7) million.

Net Income (Loss)

As a result of all these factors, net income totaled $1.9 million in the
nine months ended September 30, 2002, compared with a net loss of ($14.5)
million in the comparable period in 2001.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO DECEMBER 31, 2000

Total Revenue

Total revenue of $63.9 million for 2001 increased by $14.8 million or 30%
from the comparable period in 2000. The primary factors responsible for this
growth include a $10.2 million revenue increase from our document and PDF
conversion product line driven primarily by our release of OmniPage 11 which
contained significant enhancements over the prior version and secondarily by an
increased usage of our document conversion tool kits by software vendors,
integrators and in-house developers; $0.9 million revenue increase in our
digital paper management product line, also driven by the release of a
significantly improved new version of our PaperPort product; and a $2.7 million
revenue increase driven by a contract with an OEM customer. We also generated
additional revenue in the amount of $1.7 million from our speech products as a
result of the L&H acquisition on December 12, 2001.

North America accounted for 79% and Europe accounted for 21% of 2001 total
revenue, versus 82% and 18%, respectively, for the comparable period in 2000.
The release of international versions for two of

424B1 29th Page of 174 TOC 1st Previous Next ↓Bottom Just 29th
our digital capture products and additional sales and marketing resources in
Europe expanded the market opportunity for our digital capture products, thereby
contributing to the revenue growth in Europe for 2001.

The following table presents the breakdown of our total revenue for the
year ended December 31, 2000 and 2001:

[Download Table]

YEAR ENDED
DECEMBER 31,
-------------
2000 2001
----- -----

VAR/retail.................................................. 52% 46%
Direct...................................................... 20% 24%
OEM......................................................... 28% 30%

During 2001, our distribution and fulfillment partners, Ingram Micro and
Digital River, accounted for 28% and 15% of our total revenue, respectively. In
addition Xerox, an OEM customer, accounted for 11% of our total revenue. During
2000, Ingram Micro, Digital River and Xerox accounted for 27%, 11% and 12% of
our total revenue, respectively.

Cost of Revenue

Cost of revenue in 2001 was $12.8 million or 20% of revenue, compared to
$12.7 million or 26% of revenue in the comparable period of 2000. The decrease
in cost of revenue as a percentage of total revenue from the comparable period
in 2000 is directly attributed to the consolidation of our worldwide
manufacturing fulfillment activities and cost savings initiatives we introduced
in the second quarter of 2000. This decrease was partially offset by an increase
of $1.2 million in the cost of revenue in the second half of 2001, as a result
of costs associated with engineering efforts under an OEM contract.

Cost of Revenue from Amortization of Intangible Assets

Cost of revenue from amortization of intangible assets for 2001 was $14.2
million compared to $11.6 million for the same period in 2000. The increase in
cost of revenue from amortization of intangible assets of $2.6 million was
primarily attributable to a full year in 2001 of amortization expense for
patents and core and completed technology acquired from Caere late in the first
quarter of 2000.

Research and Development Expense

Research and development costs were $14.0 million or 22% of revenue in
2001, compared to $15.0 million or 31% of revenue in 2000. The decrease in
research and development expense as a percentage of total revenue is a result of
$1.2 million of expenses associated with engineering efforts on an OEM contract
being charged to cost of revenues as well as increased revenues of $14.8 million
compared to the prior period. Additionally, during 2000, we transferred certain
digital capture development activities from Los Gatos, California to Budapest,
Hungary.

Selling, General and Administrative Expense

Selling, general and administrative expenses were $26.4 million or 41% of
total revenue in 2001 compared to $28.2 million or 57% of total revenue for the
same period in 2000. The absolute dollar decrease in selling, general and
administrative expense from the same period in 2000 was a result of cost
reduction efforts undertaken during the first and second quarters of 2000.
Additionally, we realized a gain of approximately $1.0 million primarily due to
the favorable settlement of investment banking fees associated with the Caere
acquisition. The decrease in selling, general and administrative expense as a
percentage of revenue from the same period in 2000 is a result of the decreased
expenses as noted above, the realized gain and increased revenues compared to
the prior period.

424B1 30th Page of 174 TOC 1st Previous Next ↓Bottom Just 30th
Amortization of Goodwill and Other Intangible Assets and Acquired In-Process
Research and Development

Amortization of goodwill and other intangible assets for 2001 was $13.3
million compared to $11.0 million for the same period in 2000. The increase in
amortization of intangible assets of $2.3 million compared to the same period in
2000, resulted from a full 12 months of amortization for the Caere acquisition
being taken during 2001 versus approximately nine months in 2000 due to the
timing of the Caere acquisition which was completed on March 13, 2000. In
connection with the Caere acquisition, $18.3 million was charged to operations
upon consummation of the acquisition, which represented acquired in-process
research and development on development projects that had not yet reached
technological feasibility and had no alternative future use.

Restructuring and Other Charges, Net

There were no restructuring or other charges in 2001, compared with
approximately $4.8 million in 2000. In connection with the acquisition of Caere
in the first quarter of 2000, we identified 46 employees of Caere whose
positions were eliminated upon consummation of the acquisition. These positions
included 22 in research and development, 14 in general and administrative
functions, and 10 in sales and marketing. Additionally, the Caere president and
CEO position was eliminated. As a result, we established, as part of the
purchase price allocation, a restructuring reserve of $0.5 million for severance
payments to employees, and a restructuring reserve of $1.1 million for severance
to the Caere former president and CEO, the payments of which will continue
through March 2005.

In June 2000, we implemented a restructuring plan to strategically refocus
our business and bring operating expenses in line with net revenues. As a
result, we eliminated 65 employee positions, including 29 in research and
development, 13 in general and administrative functions and 23 in support and
marketing. We recorded a restructuring charge in the amount of $1.1 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 Los
Gatos, California facility. Additionally, we wrote off $3.5 million of net
intangible assets acquired as part of the Caere acquisition, including the
acquired work force of $1.1 million and the favorable building lease of $2.4
million, which were impaired as a result of the restructuring action. At the
time of the restructuring, management expected these restructuring actions to
reduce operating expenses by approximately $10 million on an annualized basis.
Annualized cost savings realized from these actions amounted to $13.6 million.

For the years ended December 31, 2001 and 2000, we paid $0.8 million and
$1.1 million, respectively in severance payments related to these restructuring
actions. The remaining severance balance of $0.6 million primarily relates to
severance for the former Caere President and CEO and will be paid through March
2005.

Loss from Operations

As a result of the above factors, loss from operations totaled
approximately ($16.9) million in 2001 compared to loss from operations of
approximately ($52.5) million in 2000.

Other Income (Expense), Net

Interest income was $0.2 million and $0.1 million for 2001 and 2000,
respectively. The increase in interest income from 2000 to 2001 was a result of
significantly higher cash and cash equivalent balances, which grew from $2.6
million at December 31, 2000 to $14.3 million at December 31, 2001 and short-
term investments, which were generated from operations. Interest expense
consists of interest incurred for borrowings under credit facilities and
short-term notes. Interest expense was $0.2 million and $0.6 million for 2001
and 2000, respectively. The decrease in interest expense from 2000 to 2001
resulted from the repayment of all bank borrowings, including accrued interest,
of $3.4 million, under the bank credit facility during May 2001. Other expense
in 2001 consists primarily of foreign exchange losses of $0.2 million and the
write-off of an investment of $0.2 million recorded under the cost method, which
was deemed to be impaired, partially offset by other income of $0.1 million.

424B1 31st Page of 174 TOC 1st Previous Next ↓Bottom Just 31st
Loss Before Income Taxes

As a result of the above factors, loss before income taxes was
approximately ($17.2) million in 2001 compared to a loss before income taxes of
approximately ($52.8) million in 2000.

Income Taxes

The (benefit from) income taxes of ($0.3) million for the year ended
December 31, 2001 reflects a reduction of approximately $0.7 million in amounts
accrued for income taxes upon favorable completion of a state tax audit of Caere
for 1996 and 1997. This benefit was offset by tax provisions of $0.4 million for
foreign and state jurisdictions for which net operating losses were limited or
for which no net operating loss carryforwards were available. This compares to
tax provisions of $0.5 million for the year ended December 31, 2000, which
related to foreign and state income taxes.

At December 31, 2001 and 2000, we had federal net operating loss
carryforwards of approximately $90 million and $105 million, respectively, of
which approximately $4.1 million and $2.8 million, respectively, relate to tax
deductions from stock compensation. The tax benefit related to the stock
compensation, when realized, will be accounted for as additional paid-in capital
rather than as a reduction of the provision for income tax. At December 31, 2001
we had federal and state research and development credit carryforwards of
approximately $2.8 million and $1.6 million, respectively. The net operating
loss and credit carryforwards will expire at various dates through 2021, if not
utilized. Utilization of the net operating losses and credits may be subject to
a substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization. See Note 10 of the Notes to Consolidated Financial
Statements.

Net Loss

As a result of all these factors, net loss totaled approximately ($16.9)
million in 2001, compared to a net loss of approximately ($53.3) million in
2000.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO DECEMBER 31, 1999

Total Revenue

Total revenue of $49.1 million for 2000 increased 55% compared to 1999 of
$31.6 million. The increase in absolute dollars is primarily a result of a
broader product line due to the acquisition of Caere on March 13, 2000. During
2000 product sales through direct channels, including the web sites of some of
our OEM customers, online stores and our own web store accounted for $8.8
million, or 18% of our revenue, compared to 17% of revenue in 1999.

During 2000, our distribution and fulfillment partners, Ingram Micro and
Digital River, accounted for 27% and 11% of our total revenue, respectively. In
addition Xerox, an OEM customer, accounted for 12% of our total revenue. In
1999, Ingram Micro, Tech Data and Xerox accounted for 24%, 15% and 15% of our
total revenue, respectively.

Revenue derived outside of North America, primarily in Europe, was
approximately 18% and 13% of total revenue in 2000 and 1999, respectively.
International revenue in 2000 of $9.0 million, increased by $2.2 million from
1999 due primarily to the acquisition of Caere in March 2000. Since 1999
international sales have been denominated primarily in local currencies and
these sales are subject to a number of risks inherent in doing business on an
international level, such as unexpected fluctuations in currency exchange rates,
regulatory requirements, import and export duties and restrictions, and the
logistical difficulties of managing multinational operations, any of which could
adversely impact the success of our international operations. The growth of our
international business will depend, in part, on our ability to increase
awareness of our products in international markets.

424B1 32nd Page of 174 TOC 1st Previous Next ↓Bottom Just 32nd
Cost of Revenue

Cost of revenue increased to $12.7 million or 26% of total revenue in 2000
compared to $7.6 million or 24% of total revenue in 1999. The increase in
absolute dollars and percentage of revenue was primarily attributable to the
acquisition of Caere in March 2000 that resulted in multiple manufacturing
providers, which reduced efficiencies and increased costs. By the end of 2000,
we had consolidated our manufacturing providers.

Cost of Revenue from Amortization of Intangible Assets

Cost of revenue from amortization of intangible assets for 2000 was $11.6
million compared to $1.4 million for the same period in 1999. The increase in
cost of revenue from amortization of intangible assets was primarily due to the
amortization expense for patents and core and completed technology acquired from
Caere on March 13, 2000.

Research and Development Expense

Research and development costs were $15.0 million or 31% of total revenue
in 2000, an increase of $8.1 million from the $6.9 million or 22% of total
revenue reported in 1999. The increase in research and development spending is
due to the increased software engineering headcount in connection with the
acquisition of Caere on March 13, 2000. Headcount grew from 64 engineers as of
December 31, 1999 to 111 engineers as of December 31, 2000.

Selling, General and Administrative Expense

Selling, general and administrative expense in 2000 were $28.2 million or
58% of total revenue, an increase of $13.7 million from the $14.5 million or 46%
of total revenue reported in 1999. The increase in selling, general, and
administrative expense from 1999 to 2000, was due primarily to the acquisition
of Caere on March 13, 2000.

Amortization of Goodwill and Other Intangible Assets and Acquired In-Process
Research and Development

Amortization of goodwill and other intangible assets for 2000 was $11.0
million compared to $0.5 million for the same period in 1999. The increase in
amortization expense was directly attributed to goodwill and other intangible
assets related to the Caere acquisition which was completed on March 13, 2000.

As a result of the second quarter 2000 restructuring actions described
below, certain intangible assets associated with the Caere acquisition were
impaired. Accordingly, in 2000, we wrote off $3.5 million of net intangible
assets including the acquired workforce amounting to $1.1 million and a
favorable building lease amounting to $2.4 million.

The in-process research and development charge of $3.9 million for 1999
reflects that portion of the purchase price of ScanSoft representing acquired
in-process technology that had not yet reached technological feasibility and had
no alternative future use. Accordingly, this amount was immediately charged to
expense in the consolidated statements of income upon consummation of the
acquisition.

Restructuring and Other Charges, Net

Restructuring and other charges, net, were approximately $4.8 million in
2000 compared with $346,000 in 1999. Restructuring charges of $346,000 in 1999
relate to the acquisition of ScanSoft and the subsequent consolidation of
research and development operations and the move of our headquarters to
Massachusetts, which resulted in the termination of 10 employees in California.
The major components of these costs were approximately $188,000 in severance
costs for the 10 employees and approximately $46,000 for disposed West Coast
equipment. These costs also included $82,000 in non-refundable commitments
associated with the West Coast development team, as well as $30,000 in other
exit costs. All such costs were paid in 1999.

424B1 33rd Page of 174 TOC 1st Previous Next ↓Bottom Just 33rd
Loss from Operations

As a result of the above factors, loss from operations totaled
approximately ($52.5) million in 2000, compared to a loss of approximately
($3.6) million in 1999.

Other Income (Expense), Net

Interest income was $0.1 million, and $0.2 million for 2000 and 1999,
respectively. The decrease in interest income from 1999 to 2000 was a result of
smaller invested cash balances and higher bank borrowings. Interest expense
consists of interest incurred for borrowings under credit facilities and short-
term notes. Interest expense was $0.6 million and $0.1 million for 2000 and
1999, respectively. The increase in interest expense from 1999 to 2000 resulted
from increased bank borrowings under the bank credit facility.

Loss Before Income Taxes

As a result of the above factors, loss before income taxes was
approximately ($52.8) million compared with approximately ($2.6) million in
1999.

Income Taxes

Provisions for income taxes of $0.5 million and $0.2 million for the years
ended December 31, 2000 and 1999, respectively, represent taxes for foreign and
state jurisdictions in which we do business and for which no net operating loss
carryforwards were available.

At December 31, 2000 and 1999, we had federal net operating loss
carryforwards of approximately $105 million and $60 million, respectively, of
which approximately $2.8 million and $1.3 million, respectively, related to tax
deductions from stock compensation. The tax benefit related to the stock
compensation benefit, when realized, will be accounted for as an addition to
paid in capital rather than as a reduction of the provision for income tax.
Research and development credit carryforwards as of December 31, 2000 and 1999
were $2.2 million for both years.

Net Loss

As a result of all these factors, net loss totaled approximately ($53.3)
million in 2000 compared to a net loss of approximately ($2.7) million in 1999.

Gain on Sale of the Hardware Business

In the quarter ended March 31, 1999, we sold our hardware business to
Primax Electronics, Ltd., for approximately $6.8 million and reported an
operating gain of approximately $0.9 million.

LIQUIDITY AND CAPITAL RESOURCES

Nine Months Ended September 30, 2002

As of September 30, 2002, we had cash and cash equivalents of $14.4 million
and net working capital of $15.8 million as compared to $14.3 million in cash
and cash equivalents and net working capital of $9.3 million at December 31,
2001.

Net cash provided by operating activities for the nine months ended
September 30, 2002 was $6.3 million compared to $6.1 million for the same period
in 2001. Cash provided by operations in the 2002 period came primarily from
operating income, net of non-cash adjustments, and higher balances in accrued
expenses. These increases were offset primarily by higher balances in accounts
receivable, inventory, prepaid expenses and other current assets and other
assets, and lower balances in accounts payable, as well as the recognition of
revenue on a long-term contract that was classified as deferred revenue at
December 31, 2001, for which cash was collected in a prior period.

424B1 34th Page of 174 TOC 1st Previous Next ↓Bottom Just 34th
The increase in accounts receivable of $3.4 million at September 30, 2002,
as compared to December 31, 2001 is the result of significantly higher revenue,
partially offset by improved days sales outstanding. Historically, we have not
incurred any significant losses on our accounts receivable balances.

Net cash used in investing activities during the nine months ended
September 30, 2002, was $4.9 million compared to $0.2 million for the same
period in 2001. Net cash used in investing activities during the 2002 period
consisted of $2.1 million in capital expenditures, which included costs to build
out facilities in both North America and Europe and $2.9 million of payments
associated with acquisitions. The comparable period in 2001 included capital
expenditures of $0.6 million, offset by $0.3 million in proceeds from the sale
of property and equipment.

Net cash used in financing activities for the nine months ended September
30, 2002 was $1.4 million compared to $1.1 million of net cash provided by
financing activities for the same period in 2001. Net cash used in financing
activities during the 2002 period consisted of proceeds of $2.5 million from the
exercise of stock options and net proceeds of $5.7 million from a private
placement of our common stock. This was offset by a $0.2 million payment on our
capital lease obligation, a $7.0 million payment to repurchase shares of our
common stock held by L&H, a $0.6 million payment of notes payable related to
prior acquisitions 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. Net cash provided by financing activities during the comparable
period in 2001 included proceeds of $5.0 million from a private placement of our
common stock, partly offset by payments of $3.4 million to repay in full our
prior line of credit and payments of $0.5 million to repurchase shares of our
stock on the open market.

On October 31, 2002, we entered into a two year Loan and Security Agreement
(the "Loan Agreement") with Silicon Valley Bank (the "Bank") that consisted of a
$10,000,000 revolving loan (the "Credit Facility"). Borrowings under the Credit
Facility will bear interest at the Bank's prime rate plus 0.375% or 0.75%, which
is determined by our fixed charge coverage ratio, as defined in the Loan
Agreement. The maximum aggregate amount of borrowings outstanding at any one
time will be limited to the lesser of $10,000,000 or a borrowing base. The
borrowing base will be equal to either 80% or 70% of eligible accounts
receivable, as defined in the Loan Agreement, which is determined by our fixed
charge coverage ratio. Pursuant to the Loan Agreement, we will be required to
maintain certain financial and non-financial covenants, the most restrictive of
which is a quarterly minimum fixed charge coverage ratio of 1.25 to 1.00.
Borrowings under the Loan Agreement are collateralized by substantially all of
our personal property, predominantly our accounts receivable, but not our
intellectual property. To date, no amounts have been drawn under the Credit
Facility.

In September of 2002, we repurchased 1,461,378 shares of common stock from
L&H and certain other parties at $4.79 per share for a total consideration of
$7.0 million. We also agreed to register L&H's remaining holdings of our common
stock in an underwritten public offering. This offering is being made to fulfill
this obligation. In conjunction with this obligation, we agreed to issue 150,000
shares of our common stock to L&H if we do not complete an underwritten public
offering for L&H by December 15, 2002. To fulfill this obligation, on December
18, 2002, we issued 81,900 shares to Lernout & Hauspie Speech Products N.V. and
68,100 shares to L&H Holdings USA, Inc. We further agreed to issue an additional
150,000 shares of our common stock to L&H if we do not complete an underwritten
public offering for L&H by February 15, 2003. Additionally, if we do not
complete an underwritten public offering by January 1, 2003, all of the
outstanding principal and accrued interest under the $3.5 million promissory

424B1 35th Page of 174 TOC 1st Previous Next ↓Bottom Just 35th
note, dated December 12, 2001, that we issued in connection with the L&H
acquisition will be immediately due and payable. To fulfill this obligation, on
January 3, 2003, we paid $3.3 million in full settlement of all of the
outstanding principal and accrued interest under this note.

Historically and through the first quarter of 2002, we have sustained
recurring losses from operations. In the quarters ended June 30, 2002 and
September 30, 2002, we have attained profitability. We reported net income for
the nine months ended September 30, 2002, and have an accumulated deficit of
$151.4 million at September 30, 2002. We believe that operating expense levels
in combination with expected future revenues will continue to result in positive
cash flows from operations for 2002. We also believe that we have the ability to
maintain operating expenses at levels commensurate with revenues to maintain
positive cash flows from operations. Therefore, we believe that cash flows from
future operations in addition to cash on hand and cash available from our Credit
Facility will be sufficient to meet our working capital, investing, financing
and contractual obligations as they become due, including with respect to the
Philips acquisition, for the foreseeable future.

The following table outlines our contractual payment obligations as of
September 30, 2002:

[Enlarge/Download Table]

PAYMENTS DUE BY PERIOD
---------------------------------------
WITHIN WITHIN
CONTRACTUAL OBLIGATIONS(1) TOTAL 1 YEAR 2 YEARS THEREAFTER
-------------------------- ------- ------ ------- ----------
(IN THOUSANDS)

Notes payable including interest......................... $ 3,956 $ 534 $3,422 --
Operating leases......................................... 7,608 1,799 3,559 $2,250
Caere acquisition related costs.......................... 2,457 1,638 819 --
------- ------ ------ ------
Total contractual cash obligations....................... $14,021 $3,971 $7,800 $2,250
======= ====== ====== ======

---------------

(1) Excludes the impact of the Philips acquisition and effect of payment of $3.3
million in full settlement of all of the outstanding principal and accrued
interest under the $3.5 million promissory note issued in connection with
the L&H acquisition.

We have not entered into any off balance sheet arrangements or transactions
with unconsolidated entities or other persons, except as otherwise disclosed.

Year Ended December 31, 2001

As of December 31, 2001, we had cash and cash equivalents of $14.3 million
and net working capital of $9.3 million compared to $2.6 million in cash and
short-term investments and a net working capital deficit of $6.5 million as of
December 31, 2000.

We generated $10.4 million of cash from our operating activities in 2001
compared to cash used for operations of $5.5 million in the same period in 2000.
The cash generated from operations in 2001 came primarily from the results of
operations, collection of amounts due for long-term contracts included in
deferred revenue and decreased accounts receivables at the end of the quarter,
which was offset by lower accounts payable and accrued expense balances.

Cash used in investing activities in 2001 was $10.7 million compared to
$0.4 million in cash provided in 2000. Cash used in 2001 consisted of $10.1
million for the L&H acquisition on December 12, 2001 and $0.9 million for
property and equipment acquired, which was partly offset by proceeds of $0.3
million from the sale of property and equipment. Cash provided in 2000 included
proceeds of $1.4 million acquired in connection with the Caere acquisition,
which was partially offset by the acquisition of $1.0 million of capital
equipment in the normal course of operations.

Cash provided by financing activities in 2001 was $12.4 million compared to
$2.6 million in 2000. The sale of 8.3 million shares of common stock to SWIB in
2001 yielded net proceeds of $15.7 million. This was partly offset by our
repayment of $3.4 million on our bank line of credit, which was then terminated,
and by our repurchase of approximately 656,000 shares of our common stock for
$1.0 million. The repurchase was part of a previously announced program to
repurchase up to 2 million shares of our stock

424B1 36th Page of 174 TOC 1st Previous Next ↓Bottom Just 36th
on the open market. Cash provided by financing activities in 2000 was $2.6
million, comprised primarily of borrowings of $3.4 million under our line of
credit and proceeds of $0.8 million from stock option exercises, which was
partly offset by the payment of $1.6 million of notes payable.

Our principal source of liquidity as of December 31, 2001 consisted of
approximately $14.3 million of cash and cash equivalents.

FOREIGN OPERATIONS

We develop and sell our products throughout the world. As a result of the
Caere acquisition in March 2000 and the L&H acquisition in December 2001, 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 2002, we are exposed to
changes in foreign currencies including the euro, Japanese yen and the Hungarian
forint. 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.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We develop our products in the United States, Belgium and Hungary. We sell
our products globally, primarily through an indirect reseller channel. As a
result, our financial results are affected by factors such as changes in foreign
currency exchange rates and weak economic conditions in foreign markets.

We collect a portion of our revenue and pay a portion of our operating
expenses in foreign currencies. As a result, changes in currency exchange rates
from time to time may affect our operating results. Currently, we do not
generally engage in hedging transactions to reduce our exposure to changes in
currency exchange rates, although we may do so in the future.

CRITICAL ACCOUNTING POLICIES

General

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 the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods. On an ongoing basis, we evaluate our estimates and judgments, including
those related to 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. We base
our estimates and judgments on historical experience and various other factors
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities and the amounts of revenue and expenses that are not readily
apparent from other sources.

We believe the following critical accounting policies most significantly
affect the portrayal of our financial condition and results of operations and
require our most difficult and subjective judgments.

Revenue Recognition

We apply the provisions of Statement of Position 97-2 Software Revenue
Recognition, as amended by Statement of Position 98-9 Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain "Transactions," to all
transactions involving the sale of software products. In addition, we apply the
provisions of Staff Accounting Bulletin 101, Revenue Recognition in Financial
Statements.

424B1 37th Page of 174 TOC 1st Previous Next ↓Bottom Just 37th
to distributors and resellers only when products have been sold by the
distributors or resellers to retailers or 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 inventory 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. Our accounts
receivable balance, including accounts receivable from a related party, was
$14.3 million and $17.1 million at December 31, 2001 and September 30, 2002,
respectively. These balances are net of sales returns and other allowances of
$5.5 million and $7.1 million and allowances for doubtful accounts of $0.8
million and $0.6 million as of December 31, 2001 and September 30, 2002,
respectively.

Royalty revenue derived from sales to OEM partners is recognized when
software copies are deployed and payment is due. Royalty revenue from OEM
customers for which we have significant historical experience is recognized
based on estimates of deployments in the current period. We base our estimates
on timely, informal communication with the OEM and the past payment and royalty
reporting history of our OEMs, seasonality of the OEM's business, the number of
copies deployed in previous periods and the overall economic climate that our
OEMs operate in.

We may enter into software license agreements that require significant
modification of our software. We recognize revenue with respect to these
agreements under the percentage-of-completion method. We determine progress
toward completion based upon costs incurred to date as compared with total
estimated costs at the contract completion date. If our total costs
significantly differ from our estimates, or we incur losses on these contracts,
our results of operations may be materially impacted.

On January 1, 2002, we adopted EITF 01-9, Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products),
which requires amounts paid to resellers to be treated as a reduction of
revenue, unless the consideration relates to an identifiable benefit, in which
case such consideration may be recorded as an operating expense. We evaluate our
marketing programs quarterly to ensure criteria are met for expense
classification. The implementation resulted in a $0.3 million reduction to net
revenue and a corresponding reduction of selling, general and administrative
expense for the nine months ended September 30, 2002. Additionally, it resulted
in the reclassification of $0.8 million from selling, general and administrative
expense to net revenue for the nine months ended September 30, 2001.

Valuation of Long-lived and Intangible Assets and Goodwill

We have significant long-lived tangible and intangible assets, which are
susceptible to valuation adjustments as a result of changes in various factors
or conditions. The most significant long-lived tangible and intangible assets
are fixed assets, patents, core technology, developed technology, and goodwill.
The values of intangible assets, with the exception of goodwill, were initially
determined by a risk-adjusted, discounted cash flow approach. We assess the
potential impairment of identifiable intangible assets and fixed assets whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important, which could trigger an impairment of
such assets, include the following:

- Significant underperformance relative to historical or projected future
operating results;

- Significant changes in the manner of or use of the acquired assets or the
strategy for our overall business;

- Significant negative industry or economic trends;

424B1 38th Page of 174 TOC 1st Previous Next ↓Bottom Just 38th
- Significant decline in our stock price for a sustained period; and

- A decline in our market capitalization below net book value.

Future adverse changes in these or other unforeseeable factors could result
in an impairment charge that would impact future results of operations and
financial position in the reporting period identified.

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets or SFAS 142. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. The
standard also includes provisions for the reassessment of the useful lives of
existing recognized intangible assets and the identification of reporting units
for purposes of assessing potential future impairments of goodwill. SFAS 142
required us to complete a transitional impairment test of goodwill within six
months of the date of adoption. We have reassessed the useful lives of our
existing intangible assets, other than goodwill, and believe that the original
useful lives remain appropriate. In addition, we have determined that we operate
in one reporting unit and, therefore, have completed our transitional goodwill
impairment test on an enterprise-wide level. Based on this analysis, we have
determined that goodwill recorded was not impaired, and no impairment charge has
been recorded. We will complete additional goodwill impairment analyses at least
annually, or more frequently when events and circumstances occur indicating that
the recorded goodwill might be impaired. We will perform the annual assessment
during the fourth quarter of 2002.

Significant judgments and estimates are involved in determining the useful
lives of our intangible assets, determining what reporting units exist and
assessing when events or circumstances would require an interim impairment
analysis of goodwill or other long-lived assets to be performed. Changes in
events or circumstances, including but not limited to technological advances or
competition which could result in shorter useful lives, additional reporting
units which may require alternative methods of estimating fair value, or
economic or market conditions which may affect previous assumptions and
estimates, could have a significant impact on our results of operations or
financial position through accelerated amortization expense or impairment
charges.

Determining Deferred Tax Valuation Allowances

We record a valuation allowance to reduce our deferred tax asset to an
amount that will more likely than not be realized. Through September 30, 2002,
we have recorded a full valuation allowance against our deferred tax assets.
While we have considered our ability to generate future taxable income in
assessing the need for the allowance, in the event we were to determine that we
would be able to realize our deferred tax assets in the future, an adjustment to
the deferred tax asset would increase income in the period or periods that such
determination was made.

Additionally, our deferred tax assets include significant net operating
loss carryforwards (NOLs) that we have generated or acquired as part of past
business combinations. Our ability to fully utilize these NOLs is based on a
number of factors including ownership changes resulting from the issuance of or
other changes in the ownership of our equity securities. Existing and future
ownership changes could decrease our ability to fully utilize these NOLs
therefore increasing our tax provision in the period such determination was
made.

Recently Issued Accounting Pronouncements

On December 31, 2002, the FASB issued FASB Statement No. 148 (SFAS 148),
Accounting for Stock-Based Compensation -- Transition and Disclosure, amending
FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation. This
Statement amends SFAS 123 to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, Interim
Financial Reporting, to require disclosure about those effects in

424B1 39th Page of 174 TOC 1st Previous Next ↓Bottom Just 39th
interim financial information. For entities that voluntarily change to the fair
value based method of accounting for stock-based employee compensation, the
transition provisions are effective for fiscal years ending after December 15,
2002. For all other companies, the disclosure provisions and the amendment to
APB No. 28 are effective for interim periods beginning after December 15, 2002.
We do not expect the transition provisions to have any effect on our financial
position, results of operations or cash flows.

On November 25, 2002, the FASB issued FASB Interpretation No. 45 ("FIN
45"), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of
FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.
FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for
Contingencies (SFAS 5), relating to the guarantor's accounting for, and
disclosure of, the issuance of certain types of guarantees.

FIN 45 requires that upon issuance of a guarantee, the guarantor must
recognize a liability for the fair value of the obligation it assumes under that
guarantee. FIN 45 covers guarantee contracts that have any of the following four
characteristics: (a) contracts that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, a liability, or an equity security of the guaranteed party
(e.g., financial and market value guarantees), (b) contracts that contingently
require the guarantor to make payments to the guaranteed party based on another
entity's failure to perform under an obligating agreement (performance
guarantees), (c) indemnification agreements that contingently require the
indemnifying party (guarantor) to make payments to the indemnified party
(guaranteed party) based on changes in an underlying that is related to an
asset, a liability, or an equity security of the indemnified party, such as an
adverse judgment in a lawsuit or the imposition of additional taxes due to
either a change in the tax law or an adverse interpretation of the tax law, and
(d) indirect guarantees of the indebtedness of others.

FIN 45 specifically excludes certain guarantee contracts from its scope.
Additionally, certain guarantees are not subject to FIN 45's provisions for
initial recognition and measurement but are subject to its disclosure
requirements. The initial recognition and measurement provisions are effective
for guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for our annual financial statements the year ended
December 31, 2002. We are currently evaluating the impact of FIN 45 on our
financial statements and related disclosures.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, or SFAS 146. This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring), or EITF 94-3. SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. We do not expect the adoption of SFAS 146
will have a material impact on our financial position or results of operations.

In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS
144). The objectives of SFAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS 121), and to
develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 supersedes SFAS 121; however, it retains
the fundamental provisions of SFAS 121 for (1) the recognition and measurement
of the impairment of long-lived assets to be held and used and (2) the
measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes
the accounting and reporting provisions of Accounting Principles Board No. 30,
Reporting the Results of Operations -- Reporting the Effects of

424B1 40th Page of 174 TOC 1st Previous Next ↓Bottom Just 40th
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (APB 30), for segments of a business to be
disposed of. However, SFAS 144 retains the requirement of APB 30 that entities
report discontinued operations separately from continuing operations and extends
that reporting requirement to "a component of an entity" that either has been
disposed of or is classified as "held for sale." SFAS 144 also amends the
guidance of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to eliminate the exception to consolidation for a temporarily
controlled subsidiary. SFAS 144 is effective for financial statements issued for
fiscal years beginning after December 15, 2001, including interim periods, and,
generally, its provisions are to be applied prospectively. We adopted the
provisions of SFAS 144 in 2002 and its adoption had no impact on our results of
operations.

424B1 41st Page of 174 TOC 1st Previous Next ↓Bottom Just 41st
BUSINESS

OUR BUSINESS

We incorporated as Visioneer, Inc. in March 1992 and through December 1998,
developed and sold scanner hardware and software products. On January 6, 1999,
Visioneer sold the hardware business and the Visioneer brand name to Primax
Electronics, Ltd., and on March 2, 1999, Visioneer acquired us, in a cash
election merger, from Xerox Corporation. The corporate entity "Visioneer"
survived the merger, but changed its name to "ScanSoft, Inc." In addition,
Visioneer changed the ticker symbol for its common stock that trades on the
Nasdaq National Market, to "SSFT." On March 13, 2000, we merged with Caere
Corporation, a California-based digital imaging software company. In December
2001, we acquired certain assets and intellectual property relating to the
former L&H entities that were in bankruptcy under the

424B1 42nd Page of 174 TOC 1st Previous Next ↓Bottom Just 42nd
jurisdiction of both the United States Bankruptcy Court for the District of
Delaware and the Belgium Court of Ieper and hired certain employees from those
entities.

Our focus on providing solutions that enable the capture and conversion of
information requires a broad set of technologies and channel capabilities. We
have made and expect to continue to make acquisitions of other companies,
businesses and technologies to complement our internal investments in these
areas. We have a small team that focuses on evaluating market needs and
potential acquisitions to fulfill them. In addition, we have a disciplined
methodology for integrating acquired companies and businesses after the
transaction is complete.

Since 1997, we have made four significant business acquisitions and
acquired several key technologies for aggregate consideration totalling
approximately $273.0 million.

OUR MARKETS AND PRODUCTS

DIGITAL CAPTURE MARKET

Document and PDF Conversion. Despite the broad use of computing systems in
enterprises, the majority of business information is still maintained in paper
form. The proliferation of PDF as a digital document standard does not resolve
the problem of accessing and utilizing information trapped in a static form. In
addition, manually reproducing static documents in digital form is time
consuming, costly and subject to error, taking valuable resources away from more
productive activities. Enterprises and workgroups seek solutions that integrate
paper and static PDF documents into their business processes, allowing them to
automate the way they store, edit, use and share information.

Our solutions help businesses save time and money by automatically
converting paper documents and PDF files into editable and usable business
documents. Based on optical character recognition, our software delivers highly
accurate document and PDF conversion, replacing the need to manually re-create
documents. Our software preserves document formatting and provides editing
capabilities that recreate the complex components in a typical document,
including formatted text, columns, graphics, tables and spreadsheets. Our
products can be used with existing business applications and enable the
distribution and publishing of documents to email, Internet and mobile
applications using standard file formats, including XML, HTML, PDF and Open
eBook.

The proliferation of multifunction devices and digital copiers connected
over a network has increased the number of documents that individuals within an
enterprise are transforming into digital format. Our software solutions create a
more efficient method to process static documents in enterprise content
management and database systems, thereby enhancing the value of their
investments in these systems. All of these documents can then be more easily
archived, edited and combined within the enterprise.

Our solutions are used in professional office settings, particularly in the
government, legal, finance and education sectors. Our software is available in
11 languages. We utilize a combination of our global reseller network and direct
sales to distribute our document and PDF conversion products. We license our
software to companies such as Canon, Hewlett-Packard and Xerox, which bundle our
solutions with multifunction devices, digital copiers, printers and scanners.

We also license software development toolkits to independent software
vendors, integrators and in-house developers to add document and PDF conversion
capabilities to their applications. Our independent software vendor customers
include vendors, such as Microsoft and Symantec. Our technology is also used
within high-end enterprise systems from vendors such as Kofax and Lockheed
Martin.

Digital Paper Management. As the volume and complexity of corporate data
continues to multiply, organizations are increasingly challenged in their
efforts to manage all of their paper and digital documents. The wide dispersion
of documents makes finding complete and specific information even more
difficult, time-consuming and costly. As a result, businesses need solutions
that allow individuals, workgroups or the entire organization to more
efficiently organize, find and share business documents.

424B1 43rd Page of 174 TOC 1st Previous Next ↓Bottom Just 43rd
Our solutions convert paper into digital documents that can be easily
archived, retrieved and shared. Our software can be used in conjunction with
network scanning devices to preserve an image of a document exactly as it
appears on paper. Our software automatically indexes the scanned image, so that
it can be stored together with other digital documents on a desktop, over a
network or within an enterprise content management system. In a single search,
users can quickly find scanned documents and existing digital files that match
the search criteria.

Within enterprises, workgroups and distributed teams, our product also
facilitates the movement of scanned paper and digital documents into email,
print and other business applications. This streamlines the flow of documents
between workers, decreasing the time and costs associated with managing and
using paper documents. Our solution integrates with established file systems,
such as Oracle 9i Collaboration Suite, to simplify the transfer of documents
between desktop and enterprise content management systems.

Our solutions are used in enterprises and workgroups, especially those
within the legal, healthcare, financial, government, real estate and education
industries. Our software is available in eight languages. We utilize a
combination of our global reseller network and direct sales to distribute our
digital paper management products. We also license our software to companies
such as Brother, Hewlett-Packard, and Xerox, which bundle our solutions with
multifunction devices, digital copiers, printers and scanners.

Electronic Forms. Paper forms are expensive to print, store and
distribute. They must be physically circulated for approval and, when completed,
paper forms must be collected, verified and archived. Processing paper forms
adds to this expense by requiring the manual transfer of data on completed forms
into business applications. As a result, organizations seek solutions that
implement online alternatives to the use of paper forms in order to reduce costs
and increase operational efficiency.

Our products automatically convert paper forms into fillable electronic
forms that can be easily used by enterprises and other organizations. Our
products also convert static PDF and Microsoft Word forms into fillable
electronic forms using XML, HTML and PDF standards. Our solutions simplify the
design and creation of new forms that can be delivered electronically with the
same appearance as paper. Our products enable the access and distribution of
forms through the Web and email, and can be electronically routed, approved and
digitally signed. Our solution validates form information and automates data
collection by connecting electronic forms with standard database and back office
applications.

Our solutions are used in enterprises and workgroups, especially those
within the government, financial, public safety, education, legal, healthcare
and real estate industries. Our software is available in English, French and
German. We utilize a combination of our global reseller network and direct sales
to distribute our electronic forms products. Companies such as Hewlett-Packard
bundle our solutions with multifunction devices, digital copiers, printers and
scanners, and organizations such as the U.S. Internal Revenue Service and the
Law School Admission Council license our solutions.

[Enlarge/Download Table]

PRODUCT HIGHLIGHTS
-------------------- ---------------------------------------------------------------------------------------------------------

DOCUMENT AND - Converts paper and PDF into documents that can be edited, archived and shared
PDF CONVERSION - Most widely used optical character recognition product
OmniPage - Accuracy of up to 99.8%, the highest in the industry
- Converts into XML, HTML, Open eBook, Microsoft Word, Excel and PowerPoint
- Retains precise document layout and formatting
- Integrates with enterprise content management systems
- Recognizes 114 languages
- Recent Editors' Choice Awards from PC Magazine and CNET
- Localized in 11 languages
- Available on Microsoft Windows 98/NT/2000/XP and Apple Macintosh operating systems
Capture - Toolkit of sophisticated imaging, PDF and capture capabilities
Development - Optical character recognition, handprint, checkbox and barcode recognition
System - Supports PDF, JPEG, TIFF and other image formats
- Exports Microsoft Word and Excel, RTF, ASCII, HTML, PDF and other document formats
- Recognizes more than 100 languages
- Supports over 200 scanning devices
- Available on Microsoft Windows NT/2000/XP operating systems

424B1 44th Page of 174 TOC 1st Previous Next ↓Bottom Just 44th
[Enlarge/Download Table]

PRODUCT HIGHLIGHTS
-------------------- ---------------------------------------------------------------------------------------------------------

DIGITAL PAPER - Simplifies scanning, organizing and sharing paper documents
MANAGEMENT - Index, search and retrieve scanned paper and digital documents
PaperPort - Adds document management and collaboration capabilities to Microsoft Windows
- Thumbnail based visual file management
- Adds scanning and creation of searchable PDF files to Oracle 9i
- Integrates with network file systems and content management applications
- Speeds document set assembly and connectivity to workgroup
- Localized in eight languages
- Available on Microsoft Windows 98/NT/2000/XP operating systems
ELECTRONIC - Converts paper, static PDF and Microsoft Word forms into fillable electronic forms
FORMS - Supports online filling, routing, electronic signing, validation and collection of forms
OmniForm - Connectivity with Microsoft Access, Excel, SQL Server, Oracle and other database applications
- Supports XML, HTML and PDF standards
- Localized in English, French and German
- Available on Microsoft Windows 98/NT/2000/XP operating systems

SPEECH MARKET

Speech Recognition and Dictation. Organizations demand solutions that
increase productivity by automating repetitive business processes, including the
creation of documents, data entry and completing forms. They also look for ways
to maximize the productivity of their existing workers, including those with
disabilities, and to comply with government requirements relating to workplace
safety and accessibility. Organizations also seek solutions that can reduce the
cost associated with manual transcription of professional documents. Since most
people can talk more quickly than they can type, speech is a natural way to
interact with computers to address these problems.

Our speech recognition and dictation solutions increase productivity in the
workplace by using speech to create documents, streamline repetitive and complex
tasks, input data, complete forms and automate manual transcription processes.
Our solutions allow users to automatically convert speech into text at up to 160
words-per-minute, much faster than most people can type. Our software supports a
vocabulary of more than 250,000 words that can be expanded by users to include
specialized words and phrases. Our software is designed to adapt to individual
voice patterns and accents and is highly accurate, able to achieve accuracy
rates of approximately 95%, with the ability to achieve still greater accuracy
with frequent use. Our software supports multiple languages, including Dutch,
French, German, Italian, Japanese, Spanish, Swedish, and U.S./U.K. English.

Our solutions are valuable within enterprises and workgroups for a number
of reasons. Our software can operate within a distributed network environment,
where speaker profiles can be stored on a server and accessed from any networked
computer. Our solutions also speech-enable existing business systems and
applications, including electronic records management systems and customer
service and billing applications. Our software allows a user to interact with a
computer without a keyboard or mouse, increasing the productivity of disabled
workers and those suffering from repetitive stress injury. Our solutions also
help government agencies address accessibility mandates, such as those described
in Section 508 of the U.S. Government Rehabilitation Act. We also deliver
versions of our products that are specialized for the medical, legal and public
safety vertical markets.

We offer a range of implementations, each with features that match a
specific customer target. Our solutions are also used in enterprises and
workgroups, particularly in the medical, legal, government, finance and
education sectors. Our software is available in eight languages. We utilize a
combination of our global reseller network and direct sales to distribute our
speech recognition and dictation products. We believe we gain a competitive
advantage through our established value-added reseller community, who provide
local sales, integration, training and support services to our professional
end-user community. We also license our software to companies such as Corel and
Panasonic, which bundle our solutions with some of their products.

424B1 45th Page of 174 TOC 1st Previous Next ↓Bottom Just 45th
Text-to-Speech. Organizations look for ways to reduce the costs associated
with serving their customers without sacrificing the quality of service that
they deliver. They also seek solutions that more effectively connect their
mobile workforce with real-time enterprise information, including customer data,
email and schedules, while at the same time reducing operating costs.
Text-to-speech technologies, which convert text into natural sounding
synthesized speech, are used to implement applications to achieve these goals.

We have the market-leading text-to-speech solutions. Our solutions deliver
natural sounding results by using segments of real human speech, thereby
increasing listener satisfaction especially in the delivery of multiple phrases
and sentences. Our solutions provide a single, standardized interface that
supports the creation of speech-enabled applications in 19 languages, more than
any other vendor. Our products also support the rapid and cost-effective
implementation of customized voices for specific customers. Our solutions are
highly scalable, able to handle large call volumes, and are available on many
hardware platforms and operating systems.

Our solutions are used within a wide range of applications, including
reading emails for unified messaging systems, providing prompts for interactive
voice response applications and adding text-to-speech to mobile, game and
multimedia applications. Our technology is also used in voice portals that
deliver enhanced information services, such as sports scores, news and stock
quotes. Further, companies in the automobile industry use our product to deliver
in-vehicle speech-based information services, such as directions, traffic
information and email.

We license our text-to-speech products to systems integrators, technology
providers and telecommunications companies that in turn sell an integrated
solution to businesses and end-users. This indirect, or channel-based, method of
selling allows us to focus on technology advancement while avoiding the risks
and costs associated with implementing widely varying customer and end-user
applications. We license our text-to-speech solutions to developers of telephony
applications, including Cisco and Lucent, which integrate our solutions into
hardware and software platforms. In addition, our solutions are integrated into
automotive, mobile and multimedia applications, which require high quality
text-to-speech on small-footprint, embedded hardware systems.

Voice Control. Automatic speech recognition is a speaker-independent
technology that adds voice control capabilities to applications. This technology
identifies specific words and phrases at any moment in time, converting spoken
words into instructions that control functions within applications. Automobile
and mobile communications manufacturers and their suppliers are accelerating the
development of products that require enhanced voice control capabilities. In
addition, a growing number of independent software and hardware vendors are
incorporating voice control into multimedia applications.

Our voice control solutions are based upon automatic speech recognition
technologies that allow users to interact with products simply by speaking. Our
solutions for automotive and mobile applications support a dynamic vocabulary of
up to 50,000 words and have sophisticated noise management capabilities that
ensure accuracy, even at high vehicle speeds. Our products scale to meet the
size and accuracy requirements for automotive and navigation systems and offer
rapid application development tools, extensive compatibility with hardware and
operating systems, and support for up to 13 languages. By scale, we mean that we
offer a variety of voice control solutions that are designed to meet the
individual vocabulary, operating system and memory requirements of different
applications and devices. We include toolkits with our engines that help
developers add our technologies to applications such as navigation systems,
hands-free cell phone devices and voice-activated controls in an automobile.

Our voice control solutions are embedded by tier-one, automobile, cell
phone and aftermarket system manufacturers, including Citroen, Clarion, Delphi,
Microsoft and Pioneer. By embedded, we mean our technologies are included as
part of a larger system, application or solution that is designed, manufactured
and sold by our partners. These partners include tier-one suppliers, companies
whose size and importance qualifies them to be direct suppliers to the major
automotive manufacturers, and in-dash radio, navigation system and other
electronic device manufacturers, also known as aftermarket systems providers. In
addition, Microsoft ships our product as the reference speech software
development toolkit for

424B1 46th Page of 174 TOC 1st Previous Next ↓Bottom Just 46th
Windows CE for Automotive, and independent software developers embed our speech
recognition technologies into multimedia applications.

On January 30, 2003, we acquired certain Philips Speech Processing
businesses that have added several speech recognition and voice control products
to our business. These solutions broaden our voice control technologies for
automobiles, mobile devices and consumer electronics. In addition, the
acquisition affords new opportunities to offer productivity solutions, such as
directory assistance, voice activated dialing and automated attendant
applications. In addition Philips' automatic speech recognition solutions
complement our text-to-speech capabilities for telephony-based applications.

AudioMining. Our AudioMining products are based on our speech recognition
and dictation solutions and are used to automatically create index information
for words spoken in audio and video content. Our products allow users to search
for specific audio and video content using standard text queries. Our solutions
not only present matched audio and video files, but also provide random access
to precise match locations within each audio and video file. Our solutions can
also be used to time-align existing transcripts with video clips, automating the
creation of captions. Our AudioMining solutions provide efficient access to the
information currently hidden within media files and reduce the cost associated
with creating captioned video. AudioMining is used within call center and
security applications to facilitate the retrieval of specific recorded
conversations based on the identification of key words and phrases. AudioMining
is also used by content providers to enable text queries for specific Web-based
media content, such as news, financial analyst reports, sports and talk radio.

[Enlarge/Download Table]

PRODUCT HIGHLIGHTS
-------------------- ---------------------------------------------------------------------------------------------------------

SPEECH RECOGNITION - Highly accurate automatic speech recognition
AND DICTATION - Converts speech into text at up to 160 words per minute
Dragon - Recognizes more than 250,000 words
NaturallySpeaking - Speech-enables Microsoft Windows applications
- Adds voice control to Microsoft Windows operating system
- Available in eight languages
- Vertical implementations for medical, legal and public safety markets
- Performs complex tasks simply by speaking
- Complements accessibility efforts for disabled workers
- Supports Microsoft Windows 98/NT/2000/XP
AudioMining - Automatically converts speech within audio and video into XML search index data
Development - Allows text-based search for content in audio and video content
System - Time-aligns captions for video content
- Supports word-spotting for call center and security applications
TEXT-TO-SPEECH - Industry-leading synthesized human speech solution
RealSpeak - Converts text into speech in 19 languages
- Scalable, high-density capabilities
- Supports Microsoft Windows 98/NT/2000/XP, Windows CE, Windows CE for Automotive; Sun Solaris; and
Linux operating systems
- Available on Hitachi, Intel, MIPS and NEC hardware systems
VOICE CONTROL - Highly accurate speaker-independent embedded voice recognition solution in 13 languages
ASR - Adds sophisticated command and control applications into automotive, mobile, PC and
Embedded multimedia applications
Development - Rapid application development tools
System - Accurate speech recognition engine in noisy environments, even at high vehicle speeds
- Supports Microsoft Windows 98/NT/2000/XP, Windows CE, Windows CE for Automotive; QNX; and Linux
operating systems
- Available on Hitachi, Intel, MIPS and NEC hardware systems

OUR COMPETITIVE STRENGTHS

Core Technology Assets. In recent years, we have developed and acquired
extensive technology assets, intellectual property and industry expertise in
digital capture and speech. Our technologies are based on complex mathematical
formulas, which require extensive linguistic and image data, acoustic models and
recognition techniques. A significant investment in capital and time would be
necessary to

424B1 47th Page of 174 TOC 1st Previous Next ↓Bottom Just 47th
replicate our current capabilities. We continue to invest in the advancement of
our technologies to maintain our market leading position and to develop new
applications. As of December 31, 2002 we had 250 full-time employees in research
and development, and our technologies are covered by more than 300 patents or
patent applications.

Broad Distribution Channels. We have established relationships with more
than 2,000 resellers, including leading system vendors, independent software
vendors and distributors. We maintain an extensive network of value-added
resellers to address the needs of specific markets, such as financial, legal,
healthcare and government. We believe that our extensive channel relationships
increase the difficulty for competitors to develop a similar channel network and
makes it difficult for our products to be displaced. In addition, our channel
network enables us to introduce new products quickly and effectively into the
global marketplace.

Leading Market Share. We have a strong market position in each of our
product categories and are the market leader in document and PDF conversion,
speech recognition and dictation, and text-to-speech. Approximately 78% of our
revenue for the nine months ending September 30, 2002 was derived from markets
where we are the established leader. Organizations tend to look to established
market leading vendors when making product selections. As the established brand
in our markets, we believe we can target and win more partnership arrangements
and new customers than our competition.

International Focus. The broad language coverage within our products
increases the likelihood that we will be a selected technology provider to
vendors selling globally. Our language coverage is difficult for competitors to
duplicate, and our presence in global markets limits the potential entry of new
regional competitors. With nearly one half of our staff located outside of North
America, we are able to efficiently compete on a global basis.

Multiple End Markets. We sell to a range of end markets and maintain a
tiered distribution model that provides a diversified revenue stream and broad
market exposure. We are not dependent on any single market segment or set of end
customers and earn revenue from both established and emerging markets.

OUR STRATEGY

Expand Digital Capture Solutions. We intend to enhance the value of our
digital capture solutions for enterprises to address the expanded use of content
management systems, the proliferation of PDF and the widespread adoption of
networked multifunction and digital scanning devices. We expect to introduce new
products or new versions of existing products to take advantage of these growth
opportunities. We also plan to enhance our software development toolkits so our
technologies can be integrated with more third-party solutions. We expect to
maintain product development and delivery cycles that range from 12 to 18 months
for each of our digital capture products and applications.

Pursue High Growth Markets In Speech. We intend to leverage our
technologies and market leadership in speech to expand our opportunities in the
automotive, healthcare, telecommunications, telematic and mobile markets. We
also intend to pursue emerging opportunities to use our speech technology within
consumer devices, games and other embedded applications. To expand our position,
we have introduced new versions of our products that are designed for specific
markets; completed new license agreements with customers and partners that will
resell our technologies; and completed the acquisition of Philips Speech
Processing Telephony and Voice Control business units that we believe complement
our existing solutions and resources in the telecommunications, automotive and
electronics markets.

Grow Market Share. We intend to increase our market share in each of our
product categories. In particular, we intend to expand and add features and
functions to our products to make our solutions more useful to and useable by a
larger customer base. In addition, we intend to aggressively pursue sales and
partnership opportunities to build on our leading positions in the
text-to-speech and speech recognition markets, and to capture additional market
share and increase the penetration of our products.

424B1 48th Page of 174 TOC 1st Previous Next ↓Bottom Just 48th
Expand Worldwide Channels. We intend to expand our global channel network
and build upon our existing distribution channels, especially in Europe, Asia
and Latin America. In particular, we intend to replicate our successful North
American value-added reseller channel in Europe. Along these lines, we have
added sales employees in different geographic regions and launched programs and
events to help recruit new partners for our channel network.

Capitalize on Government Initiatives. We intend to market our products
aggressively in North America and abroad to capitalize on legislative mandates
and government initiatives to put government processes online, to enhance
opportunities for workers with disabilities and to promote public safety.

Pursue Strategic Acquisitions. We have selectively pursued strategic
acquisitions. For example, during the last year we completed the L&H acquisition
and completed the Philips acquisition. We intend to continue to pursue strategic
acquisitions as a part of our growth strategy.

SALES AND DISTRIBUTION

We have established relationships with more than 2,000 channel partners,
including leading system vendors, independent software vendors, value-added
resellers and distributors, through which we market and distribute our products
and solutions. In digital capture, companies such as Brother, Canon, Hewlett-
Packard, Visioneer and Xerox include our technology in digital copiers, printers
and scanners, as well as multifunction devices that combine these capabilities.
In addition, companies such as Corel, Kofax, Lockheed Martin, Microsoft and
Symantec embed our digital capture technology into their commercial software
applications. In speech, companies such as Cisco, Dictaphone, Lucent, Matsushita
and Microsoft embed our technologies into telecommunications systems, as well as
automotive, PC or multimedia applications.

We also maintain an extensive network of value-added resellers to address
the needs of specific markets, such as financial, legal, healthcare and
government. We sell our applications to enterprises, professionals and consumers
through distribution and fulfillment partners, including 1450, Ingram Micro,
Tech Data and Digital River. These distribution and fulfillment partners provide
our products to computer superstores, consumer electronic stores, eCommerce Web
sites, mail order houses and office superstores, such as Amazon.com, Best Buy,
CDW, MicroWarehouse, Circuit City, CompUSA, Fry's Electronics, Office Depot, PC
Connection and Staples. We also maintain an extensive network of value added
resellers to address the needs of specific markets such as medical, legal and
public safety. We also sell products through our Web site at www.ScanSoft.com.

As of December 31, 2002, we employed 122 full-time sales and marketing
employees in offices worldwide.

PROPRIETARY TECHNOLOGY

We exploit our proprietary technology, trade secrets, know-how, continuing
technological innovations and licensing opportunities to maintain our
competitive position. We rely on patent law, copyright law, trade secret laws,
secrecy, technical measures, licensee agreements and non-disclosure agreements
to protect our technology, trade secrets and other proprietary rights. Our
policy is to file patent applications to protect technology, inventions and
improvements that are important to the development of our business, to maintain
a technological advantage over our competitors and to generate licensing
revenue. In this regard, we have obtained patents that directly relate to our
products. Furthermore, we obtained in the L&H acquisition 131 patents and 165
pending patent applications in speech. Our digital capture and speech
technologies are covered by more than 300 patents or patent applications. These
patents expire on various dates between 2005 and 2016.

In order to protect our ownership rights in our software products, we
license our products to OEMs and resellers on a non-exclusive basis with
contractual restrictions on reproduction, distribution and transferability. In
addition, we generally license our software in object code form only. We license
certain

424B1 49th Page of 174 TOC 1st Previous Next ↓Bottom Just 49th
of our software products to end-users by use of a "shrink-wrap" or "click wrap"
customer license that restricts the end-user to personal use of the product.

We require our employees to execute confidentiality and invention
assignment agreements in order to protect our proprietary technology and other
proprietary rights. We also rely on trade secrets and proprietary know-how.

RESEARCH AND DEVELOPMENT

The market for our products and services is characterized by rapid
technological change, frequent new product introductions and enhancements,
evolving industry standards, and rapidly changing client requirements. As a
result, we believe that our future growth is highly dependent on the timely and
efficient introduction of new and updated products and technology. As of
December 31, 2002, we employed 250 people in research and development, slightly
over half of whom are located in international locations. Our employees based in
overseas facilities extend our global focus while often lowering our overall
cost of research and development. To promote efficiency in our research and
development efforts, we have organized the effective use of global development
teams and a comprehensively integrated development process. In addition, we have
developed and refined our time-to-market process, which contributes to cost-
effective resource management while promoting technology sharing across
programs.

Our future success will depend in part on our ability to anticipate
changes, enhance our current products, develop and introduce new products that
keep pace with technological advancements and address the increasingly
sophisticated needs of our clients. Our research and development expenses for
the nine months ending September 30, 2002, and the years ending December 31,
2001, 2000 and 1999 were $21.3 million, $14.0 million, $15.0 million and $6.9
million, respectively. We expect that we will continue to commit significant
resources to research and development in the future. All research and
development expenses have been expensed as incurred.

INTERNATIONAL OPERATIONS

We currently have offices in a number of international locations including:
Australia, Belgium, Denmark, England, France, Germany, Hong Kong, Hungary,
Italy, Japan, the Netherlands, Poland, and Taiwan. The scope of our
international operations includes research and development, customer support and
sales and marketing. Our international research and development is conducted in
Budapest, Hungary and Merelbeke, Belgium. Additionally sales and support offices
are located throughout the world to support our current international customers
and to expand our international revenue opportunities.

A number of our OEM partners distribute their products throughout the world
and do not provide us with the geographical dispersion of their products. We
believe that 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 nine months ended September
30, 2002, is approximately 69% North America and 31% international, compared to
72% North America and 28% international for the comparable period in 2001.

COMPETITION

424B1 50th Page of 174 TOC 1st Previous Next ↓Bottom Just 50th
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.

Some of our competitors or potential competitors in our markets have
significantly greater financial, technical and marketing resources than we do.
These competitors may be able to respond more rapidly than we can to new or
emerging technologies or changes in customer requirements. They may also devote
greater resources to the development, promotion and sale of their products than
we do.

FACILITIES AND FULFILLMENT

Our principal administrative, sales, marketing and support functions along
with our North American imaging research and development functions occupy 45,860
square feet of space that we lease in Peabody, Massachusetts. We also lease
26,568 square feet of space in Waltham, Massachusetts where our North American
speech and language research and development is performed. These leases expire
in July 2006 and September 2006, respectively. Additionally, we lease
approximately 21,180 square feet of research and development space located in
Budapest, Hungary and 20,085 square feet in Merelbeke, Belgium, which houses our
international headquarters and research and development space. These leases
expire in December 2006 and April 2008, respectively. We also lease a number of
small sales and marketing offices in Asia and Europe, including offices located
in Amsterdam, the Netherlands; Hong Kong, China; Taipei, Taiwan; Milan, Italy;
Munich, Germany; Paris, France; Reading, England; and Tokyo, Japan.

We believe that our existing facilities are adequate for our needs for at
least the next twelve months.

Most of our software products are manufactured, packaged and shipped by
GlobalWare Solutions on a worldwide basis under a 24-month agreement we entered
into on May 1, 2002. However, we regularly investigate alternative manufacturing
and fulfillment vendors, and we believe that, if necessary, we could transition
the services provided by GlobalWare Solutions to another third party provider
without material disruption to our operations.

EMPLOYEES

As of December 31, 2002 we employed 489 people on a full-time basis, 261 in
the United States and 228 internationally. Of the total, 250 were in product
research and development, 122 in sales and marketing, 72 in operations and
support, and 45 in finance and administration. Of these employees 223 were hired
in connection with the L&H acquisition completed in December 2001. None of our
employees are subject to collective bargaining agreements. We have experienced
no work stoppages and believe that our employee relations are good. We have
utilized the services of consultants, third-party developers, and other vendors
in its sales, development, and manufacturing activities.

LEGAL PROCEEDINGS

Like many companies in the software industry, we have from time to time
been notified of claims that we may be infringing the intellectual property
rights of others. These claims have been referred to legal counsel, and they are
in various stages of evaluation and negotiation.

On November 27, 2002, AllVoice Computing plc filed an action against us in
the United States District Court for the Southern District of Texas claiming
patent infringement. In the lawsuit, AllVoice alleges that we are infringing
United States Patent No. 5,799,273 entitled "Automated Proofreading Using
Interface Linking Recognized Words to Their Audio Data While Text Is Being
Changed" (the "'273 Patent"). The '273 Patent generally discloses techniques for
manipulating audio data associated with text generated by a speech recognition
engine. Although we have several products in the speech recognition technology
field, we believe that our products do not infringe the '273 Patent because they
do

424B1 51st Page of 174 TOC 1st Previous Next ↓Bottom Just 51st
not use the claimed techniques. We believe this claim has no merit, and we
intend to defend the action vigorously.

In December 2001, the Massachusetts Institute of Technology and Electronics
For Imaging, Inc. sued us 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 we infringe 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. We have several products that permit
a user to adjust the color of an image on a computer monitor. We have asserted
that our products do not infringe the '919 Patent because our products do not
contain all elements of the structure required by the claimed invention and
because our products do not perform all of the steps required by the claimed
method. Further, we believe 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. We filed an Answer and Counterclaim on July 1, 2002. We
cannot predict the outcome of the claim, nor can we make any estimate of the
amount of damages, if any, for which we will be held responsible in the event of
a negative resolution of the claim. For the reasons described here, we believe
this claim has no merit, and we intend to defend the action vigorously.

On August 16, 2001, Horst Froessl sued us in the United States District
Court for the Northern District of California for patent infringement. In his
lawsuit, Froessl alleges that we infringe 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 we have several products in the
scanning technology field, we have asserted that our products do not infringe
the '261 Patent because our products do not contain all elements of the
structure required by the claimed invention and because our products do not
perform all of the steps required by the claimed method. Further, we believe
there may be prior art that would render the '261 Patent invalid. Damages are
sought in an unspecified amount. We filed an Answer and Counterclaim on
September 19, 2001. For the reasons described here, we believe this claim has no
merit, and we intend to defend the action vigorously.

We believe that the final outcome of these matters will not have a
significant adverse effect on our financial position and results of operations,
and we believe we will not be required to expend a significant amount of
resources defending such claims. However, should we not prevail in any such
litigation, our operating results and financial position could be adversely
impacted.

From time to time, we receive 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, we have our
counsel investigate the matter thoroughly and we take all appropriate action to
defend our rights in these matters.

424B1 52nd Page of 174 TOC 1st Previous Next ↓Bottom Just 52nd
MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information with respect to our
executive officers and directors as of December 31, 2002.

[Enlarge/Download Table]

NAME AGE POSITION
---------------------------- --- -----------------------------------------------------------------

Paul A. Ricci............... 46 Chief Executive Officer and Chairman of the Board
Michael K. Tivnan........... 50 President, Chief Operating Officer and Director
Wayne S. Crandall........... 44 Senior Vice President of Worldwide Sales and Business Development
Richard S. Palmer........... 52 Senior Vice President and Chief Financial Officer
Robert J. Weideman.......... 44 Senior Vice President and Chief Marketing Officer
Ben S. Wittner.............. 45 Senior Vice President Imaging Research and Development
Robert J. 55 Director
Frankenberg(1)(2).........
Katharine A. Martin......... 40 Director and Corporate Secretary
Mark B. Myers(1)............ 64 Director
Robert G. Teresi(1)(2)...... 61 Director

---------------

(1) Member of the audit committee.

(2) Member of the compensation committee.

Paul A. Ricci has served as our Chairman since March 2, 1999 and our Chief
Executive Officer since August 21, 2000. From January 1998 to August 2000, Mr.
Ricci was the Vice President, Corporate Business Development of Xerox. Prior to
1998, Mr. Ricci held several positions within Xerox, including serving as
President, Software Solutions Division and as President of the Desktop Document
Systems Division. Between June 1997 and March 1, 1999, Mr. Ricci served as
Chairman of the Board of Directors of ScanSoft, Inc., which was then operating
as an indirect wholly-owned subsidiary of Xerox.

Michael K. Tivnan has served as our President and Chief Operating Officer
since August 21, 2000 and has served as a director since March 1999. From March
2, 1999 until August 21, 2000, Mr. Tivnan served as our President and Chief
Executive Officer. From February 1998 until March 2, 1999, Mr. Tivnan served as
the President of ScanSoft, Inc. From November 1993 until February 1998, Mr.
Tivnan served as our General Manager and Vice President. From January 1991 until
November 1993, Mr. Tivnan served as our Chief Financial Officer.

Wayne S. Crandall has served as our Senior Vice President of Worldwide
Sales and Business Development since January of 2002. Mr. Crandall served as our
Senior Vice President Sales and Marketing from November 2000 until December of
2001. From March 2000 to November 2000, Mr. Crandall was our Senior Vice
President Sales, and from March 1995 to March 2000, he was our Vice President
Sales and Channel Marketing. From January of 1993 until March 1995 Mr. Crandall
was our Managing Director of International Sales, Marketing and Operations based
in the United Kingdom. From December 1989 until January of 1993, Mr. Crandall
was Vice President of North American Sales for Xerox Imaging Systems, a wholly
owned subsidiary of Xerox. From January of 1984 until December of 1989, Mr.
Crandall was the Director of North American Sales for Kurzweil Computer
Products. From 1978 until January of 1984, Mr. Crandall held several sales and
marketing positions with Philips N.V., Lexitron, a Division of Raytheon and
Savin Corporation.

Richard S. Palmer has served as our Senior Vice President and Chief
Financial Officer since May 2000. From July 1994 to April 2000, Mr. Palmer was
the Director of Corporate Development at Xerox Corporation. Prior to that, he
worked in a number of financial management positions at Xerox including Vice
President of Business Analysis for Xerox Financial Services, Inc., Corporate
Assistant Treasurer, and Manager of Planning and Pricing for Xerox's Latin
American Operations.

424B1 53rd Page of 174 TOC 1st Previous Next ↓Bottom Just 53rd
Robert J. Weideman became our Chief Marketing Officer and Senior Vice
President of the Company in August 2002. Mr. Weideman has served as our Vice
President, Marketing since November 2001. From February 1999 until November
2001, Mr. Weideman was Vice President of Marketing for Cardiff Software, Inc.
From August 1994 to January 1999, Mr. Weideman was Vice President of Marketing
for TGS N.V. (TGS Inc., Europe).

Ben S. Wittner has served as our Senior Vice President Imaging Research and
Development since August 2000. From March 2000 to August 2000, Dr. Wittner
served as our Vice President Technology Research and Development. From February
1995 until March 2000, Dr. Wittner was Director of OCR Research and Development
of ScanSoft, Inc., which was then operating as an indirect wholly-owned
subsidiary of Xerox. Dr. Wittner joined ScanSoft in 1992 as manager of text
recognition for OCR development. Previously, Dr. Wittner was an individual
contributor and then supervisor for the handwriting recognition project at
NYNEX. Before that, he held a post-doctoral position at AT&T Bell Laboratories,
researching fundamentals and applications of neural networks. Dr. Wittner earned
a Ph.D. in mathematics from Cornell University.

Robert J. Frankenberg has served as a director since March 13, 2000. Since
December 1999, Mr. Frankenberg has served as Chairman of Kinzan, Inc., an
Internet Services software platform provider. From May 1997 to July 2000, Mr.
Frankenberg served as the Chairman, President and Chief Executive Officer of
Encanto Networks, Inc., a developer of hardware and software designed to enable
creation of businesses on the Internet. Since July 2000, he has continued as
Chairman, and since January 2001, he served as Acting President and CEO. From
April 1994 to August 1996, he was Chairman, President and Chief Executive
Officer of Novell, Inc., a producer of network software. He is a director of
Electroglas, Inc., National Semiconductor, Daw Technologies, Inc. and Secure
Computing Corporation.

Katharine A. Martin has served as a director since December 17, 1999. Since
March 2, 1999, Ms. Martin has served as our Corporate Secretary. Since September
1999, Ms. Martin has served as a Member of Wilson Sonsini Goodrich & Rosati,
Professional Corporation. Wilson Sonsini Goodrich & Rosati serves as our primary
outside corporate and securities counsel. Prior thereto, Ms. Martin was a
Partner of Pillsbury Madison & Sutro LLP.

Mark B. Myers has served as a director since March 2, 1999. Dr. Myers
served as Senior Vice President, Xerox Research and Technology, responsible for
worldwide research and technology from February 1992 until December 1999. Dr.
Myers is presently on the faculty of the Wharton Business School, The University
of Pennsylvania.

Robert G. Teresi has served as a director since March 13, 2000. Mr. Teresi
served as the Chairman of the Board, Chief Executive Officer and President of
Caere Corporation from May 1985 until March 2000.

BOARD COMMITTEES

Our audit committee consists of Messrs. Frankenberg, Myers and Teresi. The
audit committee reviews our internal accounting procedures and consults with and
reviews the services provided by our independent accountants.

Our compensation committee consists of Messrs. Frankenberg and Teresi. The
compensation committee reviews and recommends to the board of directors the
compensation and benefits of our employees.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

During 2001, no member of the compensation committee was an officer or
employee of ScanSoft. During 2001, no member of the compensation committee or
executive officer of ScanSoft served as a member of the board of directors or
compensation committee of any entity that has an executive officer serving as a
member of our board of directors or compensation committee.

424B1 54th Page of 174 TOC 1st Previous Next ↓Bottom Just 54th
COMPENSATION OF NON-EMPLOYEE DIRECTORS

Our non-employee directors are entitled to participate in the 1995
Directors' Stock Option Plan. Options granted under this plan constitute the
sole compensation for board service. The plan, as amended in June 2001, provides
that each non-employee director will receive an initial option grant to purchase
50,000 shares of our common stock at an exercise price equal to the fair market
value of the stock on the respective effective date of the grant. Each option is
exercisable in installments, 25% each year beginning on the first anniversary of
the grant so that the options are 100% exercisable four years after the
effective date of the grant. The Plan also provides for the automatic annual
grant of stock options to purchase 15,000 shares of common stock to each
non-employee director on January 1 of each year, provided that, on such date, he
or she shall have served on our board for at least six months. These annual
grants become fully vested and exercisable on the first anniversary of the date
of grant. On January 2, 2001, each non-employee director was granted an option
to purchase 5,000 shares of our common stock, pursuant to the Plan (which had
not yet been amended). The June 2001 amendment also allowed for the non-
automatic grant of 40,000 shares of common stock to all non-employee directors
who were outside directors on January 23, 2001 ("Eligible Directors").
Accordingly, each Eligible Director received a grant of 40,000 shares on June
27, 2001 at an exercise price of $1.18, the market price on that date, which
amounted to 160,000 shares in the aggregate. These June 27, 2001 options became
fully vested and exercisable on June 27, 2002, the first anniversary of the date
of grant.

EXECUTIVE COMPENSATION

The following table provides certain summary information for the fiscal
years 2002, 2001 and 2000 concerning compensation earned by our Chief Executive
Officer and to our four other most highly compensated named executive officers
whose compensation exceeded $100,000 in 2002 (the "Named Executive Officers").

[Enlarge/Download Table]

LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION ------------------------
------------------------------------------ RESTRICTED SECURITIES
NAME AND OTHER ANNUAL STOCK UNDERLYING ALL OTHER ANNUAL
PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION AWARD(S)($) OPTIONS(#) COMPENSATION(2)
------------------ ---- -------- -------- ------------ ----------- ---------- ----------------

Paul A. Ricci........ 2002 $299,000 $ 25,000(3) $107,000(4) -- 1,011,554 $ --
Chief Executive 2001 300,000 39,700 52,746(4)(5) -- -- --
Officer 2000(6) 110,385 12,248 -- -- 2,505,000 --
Michael K. Tivnan.... 2002 274,516 25,000(3) -- -- 122,918 8,000
President and Chief 2001 275,016 99,250 5,289(5) -- -- 7,062
Operating
Officer(7) 2000 269,180 36,378 5,289(5) -- 330,000 8,250
Wayne S. Crandall.... 2002 224,500 -- -- -- 263,125 7,125
Senior Vice
President, 2001 225,000 67,382 4,327(5) -- -- 9,154
Sales and Business 2000 180,673 58,102 577(5) -- 200,000 6,773
Development
Richard S. Palmer.... 2002 219,500 -- -- -- 14,667 6,967
Senior Vice
President 2001 220,000 69,872 4,231(5) $ 90,750(8) 100,000 7,017
and Chief Financial 2000(9) 155,833 25,868 4,231(5) 550,000 --
Officer
Robert Weideman...... 2002(10) 209,500 42,000 19,943(12) $200,002(11) 10,500 6,650
Chief Marketing
Officer, Senior
Vice President

---------------

(1) Unless specified otherwise, bonuses were paid pursuant to Bonus Incentive
Plans.

(2) Represents ScanSoft's contributions to our 401(k) plan.

(3) Represents a bonus paid for successful completion of Lernout & Hauspie
acquisition.

(4) Includes allowance paid for remote living expenses.

(5) Includes payment of one week of accrued vacation.

(6) Mr. Ricci began operating in this capacity in August 2000.

(7) Mr. Tivnan served as President and Chief Executive Officer from March 1999
to August 2000, and thereafter as President and Chief Operating Officer.

424B1 55th Page of 174 TOC 1st Previous Next ↓Bottom Just 55th
(8) Mr. Palmer received a Restricted Stock Award for 75,000 shares. This
Restricted Stock Award has a 2 1/2 year cliff vesting, which vests 100% on
April 17, 2004. The value of the Restricted Stock Award as of December 31,
2002 was $390,000.

(9) Mr. Palmer joined us in May 2000.

(10) Mr. Weideman began operating in this capacity in August, 2002.

(11) Mr. Weideman received a Restricted Stock Award in November 2001 for 58,824
shares. This Restricted Stock Award vests in equal installments of 1/3 on
each anniversary date. On November 27, 2002, 19,608 shares vested at a
value of $147,060. The value of the unvested Restricted Stock holdings as
of December 31, 2002 was $203,923.

(12) Represents reimbursement of relocation expenses.

CHANGE IN CONTROL AND EMPLOYMENT AGREEMENTS

Our board approved the acceleration of vesting of options for certain of
our officers and our directors in the event of a change in control. A change in
control includes a merger or consolidation of ScanSoft not approved by our
board, certain changes in the composition of our board, and certain changes in
the ownership of ScanSoft.

Mr. Ricci serves as our Chief Executive Officer and Chairman of the Board.
Under the terms of his August 21, 2000 employment agreement, his annual base
compensation is $300,000 and he is eligible for a target bonus of $50,000 per
year. The agreement also provided for a grant of 2,500,000 options at $1.3438
per share, subject to 1/8 vesting per quarter over a two year period. Mr.
Ricci's severance (in the event of involuntary termination other than for cause,
death or disability) under the employment agreement would entitle him to, among
other things, a lump-sum payment equal to 8.5% of his base salary and target
bonus, and acceleration of vesting of all options held by him that were unvested
immediately prior to termination. Additionally, upon a change in control, Mr.
Ricci also would be entitled to vesting of all of his unvested options. Mr.
Ricci's employment agreement was amended in July 2001 to provide him with a
living expenses allowance, not to exceed $107,000.00 annually, in connection
with his relocation to the Peabody, Massachusetts area, where our corporate
headquarters are located.

Mr. Tivnan serves as our President, Chief Operating Officer and director.
Under the terms of his August 21, 2000 employment agreement, his annual base
compensation is $275,000 and he is eligible to receive a target bonus of up to
45% of his base salary per year. The agreement also provides for a grant of
250,000 options at $1.3438 per share, with vesting in full on the first year
anniversary of the grant. Mr. Tivnan's severance (in the event of voluntary or
involuntary termination, other than for cause, death or disability) under the
employment agreement would entitle him to, among other things, payment of his
base salary for a period of one year following termination, and a one-year
period following termination to exercise his vested options.

Mr. Crandall serves as our Senior Vice President of Worldwide Sales and
Business Development. Under the terms of a vesting agreement that he entered
into with us in April 1999, all of Mr. Crandall's unvested stock options will
immediately vest upon his involuntarily or constructive termination prior to,
but in contemplation of, or within twelve months after, a change in control.

Mr. Wittner serves as our Senior Vice President of Imaging Research and
Development. Under the terms of a Company letter addressed to Mr. Wittner in
July 2000 in the event there is a change in control of the Company and Mr.
Wittner's employment is terminated within twelve months of the change in
control, all of his stock options will become fully vested as of the effective
date of the termination of his employment. Additionally, in the event that Mr.
Wittner's position with the Company is eliminated for any reason other than for
cause, Mr. Wittner would be entitled to 52 weeks of severance pay, based on his
base salary at the time of termination.

424B1 56th Page of 174 TOC 1st Previous Next ↓Bottom Just 56th
RECENT OPTION GRANTS

The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 2002 to the Named Executive
Officers.

[Enlarge/Download Table]

PERCENT OF POTENTIAL REALIZABLE VALUE
TOTAL OPTIONS AT ASSUMED ANNUAL RATES OF
SECURITIES GRANTED TO STOCK PRICE APPRECIATION FOR
UNDERLYING EMPLOYEES EXERCISE OR OPTION TERM($)(2)
OPTIONS IN FISCAL BASE PRICE EXPIRATION -----------------------------
NAME GRANTED(#) YEAR(%)(1) ($/SHARE) DATE 5% 10%
---- ---------- ------------- ----------- ---------- ------------- -------------

Paul Ricci............ 11,554(3) .2362 5.3600 04/29/12 38,947.09 98,699.58
550,000(4) 11.2453 5.3600 04/29/12 1,853,981.36 4,698,352.77
450,000(4) 9.2007 6.9700 06/14/12 1,972,528.00 4,998,773.23
Michael Tivnan........ 22,918(3) .4686 5.3600 04/29/12 77,253.72 195,776.09
100,000(5) 2.0446 5.3600 04/29/12 337,087.52 854,245.96
Wayne Crandall........ 50,000(6) 1.0223 4.7000 02/11/12 147,790.24 374,529.48
13,125(3) .2684 5.3600 04/29/12 44,242.74 112,119.78
100,000(7) 2.0446 5.3600 04/29/12 337,087.52 854,245.96
100,000(7) 2.0446 6.9700 06/14/12 438,339.55 1,110,838.49
Richard S. Palmer..... 14,667(3) .2999 5.3600 04/29/12 49,440.63 125,292.25
Robert Weideman....... 10,500(3) .2147 5.3600 04/29/12 35,394.19 89,695.83

---------------

(1) Based on options to purchase an aggregate of 4,890,913 shares of common
stock granted to employees during fiscal 2002.

(2) Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. These gains
are based on assumed rates of stock appreciation of five percent (5%) and
ten percent (10%) compounded annually from the date the respective options
were granted to their expiration date and are not presented to forecast
possible future appreciation, if any, in the price of our common stock. The
gains shown are net of the option exercise price, but do not include
deductions for taxes or other expenses associated with the exercise of the
options or the sale of the underlying shares of common stock. The actual
gains, if any, on the stock option exercises will depend on the future
performance of our common stock, the optionee's continued employment through
applicable vesting periods and the date on which the options are exercised.

(3) Options granted to Mr. Ricci, Mr. Tivnan, Mr. Crandall, Mr. Palmer and Mr.
Weideman have a ten year term, and are exercisable 50% on August 31, 2002
and 50% on February 28, 2003.

(4) Options granted to Mr. Ricci have a ten year term, and are exercisable over
a two year period commencing one month after grant date.

(5) Options granted to Mr. Tivnan have a ten year term, and are 100% exercisable
on the grant anniversary date.

(6) Options granted to Mr. Crandall have a ten year term, and are exercisable
over a two year period commencing 3 months after grant date and monthly
thereafter.

(7) Options granted to Mr. Crandall have a ten year term, and are exercisable
over a four year period commencing 1 year after grant date and monthly
thereafter.

The following table shows the number of shares of common stock represented
by outstanding stock options held by each of the Named Executive Officers as of
December 31, 2002. (No stock appreciation rights were granted by the Company in
2002 and none were outstanding at December 31, 2002.)

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES(1)

[Enlarge/Download Table]

NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT 12/31/02 OPTIONS/SARS AT 12/31/02
SHARES ACQUIRED VALUE --------------------------- ---------------------------
ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
--------------- -------- ----------- ------------- ----------- -------------

Paul A. Ricci........ -- -- 2,821,609 714,945 $9,695,400 $ 17,550
Michael K. Tivnan.... -- -- 988,395 216,459 3,640,686 232,050
Wayne Crandall....... -- -- 502,781 315,126 1,779,034 198,281
Richard S. Palmer.... -- -- 494,834 169,833 1,463,055 401,750
Robert Weideman...... -- -- 140,666 369,834 243,749 656,251

424B1 57th Page of 174 TOC 1st Previous Next ↓Bottom Just 57th
---------------

(1) Based on a per share price of $5.20, the closing price of our common stock
as reported by The Nasdaq National Market on December 31, 2002, the last
trading day of the fiscal year, less the exercise price. The actual value of
unexercised options fluctuates with stock market activity.

COMPENSATION PLANS

1993 Incentive Stock Option Plan

Our 1993 Incentive Stock Option Plan (the "1993 Plan") was adopted by our
board and approved by our stockholders in February 1993. The 1993 Plan was last
amended by our board in June 2000.

General. The 1993 Plan provides for the granting of incentive stock
options within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended (the "Code"), and for the granting of nonstatutory stock options. As
of December 31, 2002, 1,363,904 shares had been issued upon exercise of options
granted under the 1993 Plan, options to purchase 2,506,085 shares were
outstanding, and 11 shares remained available for future grant. As of December
31, 2002, the fair market value of all shares of common stock subject to
outstanding options was $13,031,642, based on the closing sale price of $5.20
for our common stock as reported on the Nasdaq National Market on December 31,
2002. As of December 31, 2002, (i) options to purchase 1,883,713 shares of
common stock were outstanding under the Plan and held by all current executive
officers as a group, (ii) no options were outstanding and held by current
directors who are not executive officers and (iii) options to purchase 622,372
shares of common stock were outstanding and held by employees, including current
officers who are not executive officers, and consultants.

The 1993 Option Plan is not a qualified deferred compensation plan under
Section 401(a) of the Code, and is not subject to the provisions of the Employee
Retirement Income Security Act of 1974, as amended. The maximum aggregate number
of shares which may be optioned and sold under the Plan is 3,870,000.

Purpose. The 1993 Plan seeks to attract and retain the best available
personnel for our company, give our employees, officers, directors and
consultants a greater personal stake in the success of our business, and provide
these individuals with added incentive to continue and advance in their
employment or services to our company.

Administration. The 1993 Plan may be administered by our board or by a
committee designated by our board (the "Administrator"); it is currently
administered by our board and the compensation committee of the board. Members
of the board receive no additional compensation for their services in connection
with the administration of the 1993 Plan. All questions of interpretation of the
Plan are determined by the Administrator, and decisions of the Administrator are
final and binding upon all participants.

Eligibility. The 1993 Plan provides that options may be granted to our
employees (including officers and directors who are also employees) and
consultants. Incentive stock options may be granted only to employees. The
Administrator selects the optionees and determines the number of shares and the
exercise price to be associated with each option. In making such determination,
there are taken into account the duties and responsibilities of the optionee,
the value of the optionee's services, the optionee's present and potential
contribution to our success, and other relevant factors. As of December 31,
2002, there were approximately 489 employees eligible to participate in the 1993
Plan. The Plan provides that the maximum number of shares of common stock which
may be granted under options to any one employee during any fiscal year is
500,000, subject to certain adjustments. There is also a limit on the aggregate
market value of shares subject to all incentive stock options that may be
granted to an optionee during any calendar year.

Terms of Options. The terms of options granted under the 1993 Plan are
determined by the Administrator. Each option is evidenced by a stock option
agreement between us and the optionee and is subject to, among other things, the
following terms and conditions:

(a) Exercise of the Option. The optionee must earn the right to
exercise the option by continuing to work for us. The Administrator
determines when options are exercisable. An option is

424B1 58th Page of 174 TOC 1st Previous Next ↓Bottom Just 58th
exercised by giving written notice of exercise to us specifying the number
of full shares of common stock to be purchased, and by tendering payment of
the purchase price to us. The method of payment of the exercise price of
the shares purchased upon exercise of an option is determined by the
Administrator.

(b) Exercise Price. The exercise price of options granted under the
1993 Option Plan is determined by the Administrator, and must be at least
equal to the fair market value of the shares on the date of the first
grant, in the case of incentive stock options, and must not be less than
100% of the fair market value per share on the date of grant, in the case
of nonstatutory incentive stock options, based upon the closing price on
the Nasdaq National Market on the date of grant. Incentive stock options
granted to stockholders owning more than 10% of our outstanding stock are
subject to the additional restriction that the exercise price on such
options must be at least 110% of the fair market value on the date of the
grant. Nonstatutory stock options granted to a covered employee under
Section 162(m) of the Code are subject to the additional restriction that
the exercise price on such options must be at least 100% of the fair market
value on the date of grant.

(c) Termination of Employment. If the optionee's employment or
consulting relationship with us is terminated for any reason other than
death or total and permanent disability, options under the 1993 Plan may be
exercised not later than three months (or such other period of time not
exceeding 3 months and no less than 30 days as determined by the
Administrator) after the date of such termination to the extent the option
was exercisable on the date of such termination. In no event may an option
be exercised by any person after the expiration of its term.

(d) Termination of Options. Incentive stock options granted under the
1993 Option Plan expire 10 years from the date of grant unless a shorter
period is provided in the option agreement. Incentive stock options and
nonstatutory stock options granted to stockholders owning more than 10% of
our outstanding stock may not have a term of more than five years and five
years and one day, respectively.

(e) Nontransferability of Options. Options are nontransferable by the
optionee, other than by will or the laws of descent and distribution, and
are exercisable only by the optionee during his or her lifetime.

(f) Acceleration of Option. In the event of a sale of all or
substantially all of our assets, or the merger of our company with another
corporation, an option granted under the 1993 Plan will be assumed or an
equivalent option will be substituted by such successor corporation or a
parent or subsidiary of such successor corporation. The Administrator may,
in its discretion, make provisions for the acceleration of the optionee's
right to exercise his or her outstanding options in full.

Amendment and Termination. The board of directors may amend the 1993 Plan
at any time or from time to time or may terminate it without approval of the
stockholders, with certain exceptions. The 1993 Option Plan will terminate in
February 2003, but any options then outstanding under the 1993 Plan will remain
outstanding until they expire by their terms.

1995 Employee Stock Purchase Plan

Our 1995 Employee Stock Purchase Plan (the "1995 ESPP") was adopted by our
board and approved by our stockholders in November 1995. It was last amended and
restated as of April 27, 2000.

General. The 1995 ESPP is intended to qualify under the provisions of
Section 423 of the Code, is not a qualified deferred compensation plan under
Section 401(a) of the Code, and is not subject to the provisions of ERISA. A
total of 1,000,000 are authorized to be issued under the 1995 ESPP. As of
December 31, 2002, a total of 688,388 shares had been issued to our employees
under the 1995 ESPP, and 311,612 shares remained available for future issuance.
The average per share issuance price for shares purchased by employees under the
1995 ESPP to date is approximately $2.7414. As of December 31, 2002,
approximately 264 employees were eligible to participate in the 1995 ESPP.

424B1 59th Page of 174 TOC 1st Previous Next ↓Bottom Just 59th
Purpose. The purpose of the 1995 ESPP is to provide employees with an
opportunity to purchase our common stock through accumulated payroll deductions.
Employees make such purchases by participation in regular offering periods from
which they may withdraw at any time.

Administration. The 1995 ESPP may be administered by our board or a
committee appointed by our board. Currently the 1995 ESPP is administered by our
board. Our board or its committee has full power to adopt, amend and rescind any
rules deemed desirable and appropriate for the administration of the 1995 ESPP,
to construe and interpret the 1995 ESPP, and to make all other determinations
necessary or advisable for the administration of the 1995 ESPP.

Eligibility. Any person who, on the first day of an offering period, is
customarily employed by us for at least 20 hours per week and more than five
months in any calendar year is eligible to participate in the 1995 ESPP.

Offering Dates. In general, the 1995 ESPP is implemented by a series of
offering periods of 12 months duration, with new offering periods commencing on
or about February 16 and August 16 of each year. Each offering period consists
of two consecutive purchase periods of six months duration, with the last day of
such period being designated a purchase date. Our board has the power to change
the duration and frequency of the offering and purchase periods with respect to
future offerings without stockholder approval if such change is announced at
least fifteen days prior to the scheduled beginning of the first offering or
purchase period to be affected.

Participation in the Plan. Eligible employees may participate in the 1995
ESPP by completing an enrollment form provided by us and filing it with us prior
to the applicable offering date, unless a later time for filing the enrollment
form is set by our board for all eligible employees with respect to a given
offering. The enrollment form currently authorizes payroll deductions of not
less than 1% and not more than 12% of the participant's eligible compensation on
the date of the purchase.

Purchase Price. The purchase price per share sold under the 1995 ESPP is a
price equal to the lower of 85% of the fair market value of the common stock at
the beginning of the offering period or the purchase date. The fair market value
is the per share closing price of the common stock on the Nasdaq National Market
as of such date reported by Nasdaq.

Payment of Purchase Price; Payroll Deductions. The purchase price of the
shares is accumulated by payroll deductions during the offering period. The
deductions may be up to 12% of a participant's eligible compensation received on
each payday during the offering period. Eligible compensation is defined in the
1995 ESPP to include the regular straight time gross earnings excluding payments
for overtime, shift premium, incentive compensation, bonuses and commissions. A
participant may discontinue his or her participation in the 1995 ESPP at any
time during the offering period prior to a purchase date, and may decrease the
rate of his or her payroll deductions once during the offering period by
completing and filing a new enrollment form. No interest accrues on the payroll
deductions of a participant in the 1995 ESPP.

Purchase of Stock; Exercise of Option. By executing an enrollment form to
participate in the 1995 ESPP, the participant is entitled to have shares placed
under option. Unless the participant's participation is discontinued, each
participant's option for the purchase of shares will be exercised automatically
at the end of each purchase period at the applicable price. Notwithstanding the
foregoing, no participant shall be permitted to subscribe for shares under the
1995 ESPP if immediately after the grant of the option he or she would own 5% or
more of the voting power or value of all classes of our stock or of any of our
subsidiaries (including stock which may be purchased under the 1995 ESPP or
pursuant to any other options), nor shall any participant be granted an option
which would permit the participant to buy pursuant to all of our employee stock
purchase plans more than $25,000 worth of stock (determined at the fair market
value of the shares at the time the option is granted) in any calendar year.

Termination of Employment. Upon termination of a participant's continuous
status as an employee prior to the purchase date of an offering period for any
reason, including retirement or death, he or she will be deemed to have elected
to withdraw from the Plan and the contributions credited to his or her account
but not yet used to exercise his or her option under the Plan will be returned
to him or her.
57

424B1 60th Page of 174 TOC 1st Previous Next ↓Bottom Just 60th
Nontransferability. No rights or accumulated payroll deductions of a
participant under the 1995 ESPP may be pledged, assigned or transferred for any
reason.

Amendment and Termination of the Plan. The board of directors may at any
time amend or terminate the 1995 ESPP, except that such termination shall not
affect options previously granted.

1995 Directors' Stock Option Plan

Our 1995 Directors' Stock Option Plan (the "1995 Directors' Plan") was
adopted by our board and approved by our stockholders in October, 1995, and was
last amended by our board on April 5, 2002 and by our stockholders on June 14,
2002. As of December 31, 2002, there were options to purchase 355,000 shares of
common stock outstanding under the 1995 Directors' Plan, with exercise prices
ranging from $0.6563 to $5.9375 per share. Additionally, as of the same date,
450,000 shares remained available for future grant under the Plan.

General. The 1995 Directors' Plan currently provides for the
non-discretionary grant of non-statutory stock options. Non-statutory stock
options granted under the Plan are intended not to qualify as incentive stock
options within the meaning of Section 422 of the Code.

Purpose. We, by means of the 1995 Directors' Plan, seek to attract and
retain the best available personnel for service as directors of our company, to
provide additional incentive for such persons to exert maximum efforts to
promote the success of our company, and to encourage their continued service on
our board.

Administration. Our board administers the 1995 Directors' Plan. The board
has the power to construe and interpret the Plan and options granted under it,
to establish, amend, and revoke rules and regulations for its administration, to
amend the Plan, and generally to exercise such powers and to perform such acts
as the board deems necessary or expedient to promote our best interests.

Eligibility. Options may be granted under the 1995 Directors' Plan only to
our non-employee directors. A "non-employee director" is a director who is not
an employee of our company or of any "parent" or "subsidiary" of our company, as
those terms are defined in the Code. The payment of a director's fee by us is
not sufficient in and of itself to constitute "employment" by us. Four of our
six current directors (all except Messrs. Ricci and Tivnan) are eligible to
participate in the 1995 Directors' Plan.

Stock Subject to the 1995 Directors' Plan. If options granted under the
1995 Directors' Plan expire or otherwise terminate without being exercised, the
common stock not purchased pursuant to such options again becomes available for
issuance under the Plan. The number of shares authorized for issuance under the
1995 Directors' Plan is 820,000.

Terms and Conditions of Options. Each option under the 1995 Directors'
Plan is subject to the following terms and conditions:

(a) Non-Discretionary Grants. Option grants are non-discretionary.
Each non-employee director is automatically granted an option to purchase
shares of common stock as follows:

- An initial grant of 50,000 on the date the person first becomes a
non-employee director; and

- An annual, subsequent grant of 15,000 on January 1 of each year,
provided that, on such date, the non-employee director has served on
the board for at least six months.

At the June 2001 meeting, the stockholders approved a non-automatic
grant to any director who was an eligible director on January 23, 2001 of
an additional 40,000 shares. The 40,000 options consist of (i) 30,000
shares to raise their initial grant from 20,000 to 50,000 and (ii) 10,000
shares to raise their subsequent grant from 5,000 to 15,000 (before the
June 2001 amendment, the initial grant comprised 20,000 shares and the
subsequent grant comprised 5,000 shares). Each eligible director was
granted 40,000 options on June 27, 2001.

424B1 61st Page of 174 TOC 1st Previous Next ↓Bottom Just 61st
(b) Exercise Price; Payment. The exercise price of each option
granted under the 1995 Directors' Plan is equal to 100% of the fair market
value of the common stock subject to such option on the date such option is
granted.

We may not: reduce the exercise price of any stock option, including
stock appreciation right, outstanding or to be granted in the future under
the 1995 Directors' Plan; cancel and re-grant options at a lower exercise
price (including entering into any "6 month and 1 day" cancellation and
re-grant scheme), whether or not the cancelled options are put back into
the available pool for grant; replace underwater options with restricted
stock in an exchange, buy-back or other scheme; or replace any options with
new options having a lower exercise price or accelerated vesting schedule
in an exchange, buy-back or other scheme.

(c) Option Vesting. Options granted pursuant to the 1995 Directors'
Plan may be exercised while the non-employee director is a director of our
company and for a period of 90 days after ceasing to be a director. The
exercise price per share of the option is 100% of the fair market value per
share on the grant date. The initial grant vests over four years in 25%
installments on the anniversary of the grant date. The subsequent grant is
exercisable as to 100% of the shares subject to the subsequent grant on the
first anniversary of the date of grant of the subsequent grant.

(d) Termination of Options. Currently no option granted under the
1995 Directors' Plan is exercisable after the expiration of ten years from
the date the option was granted.

(e) Non-transferability of Options. Options granted under the 1995
Directors' Plan are not transferable except by will or by the laws of
descent and distribution, and are exercisable during the lifetime of the
person to whom the option is granted only by such person or by his or her
guardian or legal representative.

Adjustment Provisions. If there is any change in the stock subject to the
1995 Directors' Plan or subject to any option granted under the 1995 Directors'
Plan (through merger, consolidation, reorganization, re-capitalization, stock
dividend, dividend in property other than cash, stock split, liquidating
dividend, combination of shares, exchange of shares, change in corporate
structure, or otherwise), the 1995 Directors' Plan and options outstanding
thereunder will be appropriately adjusted as to the class and maximum number of
shares subject to the 1995 Directors' Plan and the class, number of shares, and
price per share of stock subject to such outstanding options.

Effect of Certain Corporate Events. In the event of (i) a dissolution or
liquidation of our company, (ii) a sale of all or substantially all of our
assets, (iii) a merger or consolidation in which we are not the surviving
corporation, or (iv) any other capital reorganization in which more than 50% of
the shares of our company entitled to vote are exchanged, we shall give to
directors, at the time of adoption of the plan for liquidation, dissolution,
sale, merger, consolidation or reorganization, either a reasonable time
thereafter within which to exercise the option, including shares as to which the
option would not be otherwise exercisable, prior to the effectiveness of such
liquidation, dissolution, sale, merger, consolidation or reorganization, at the
end of which time the option shall terminate, or the right to exercise the
option, including shares as to which the option would not be otherwise
exercisable (or receive a substitute option with comparable terms), as to an
equivalent number of shares of stock of the corporation succeeding our company
or acquiring our business by reason of such liquidation, dissolution, sale,
merger, consolidation or reorganization.

Duration, Amendment, and Termination. The board may suspend or terminate
the 1995 Directors' Plan at any time. Unless sooner terminated, the 1995
Directors' Plan terminates in October 2005. The board also may amend or
terminate the Plan from time to time in such respects as the board may deem
advisable.

424B1 62nd Page of 174 TOC 1st Previous Next ↓Bottom Just 62nd
Plan Benefits. The following shows the benefits or amounts that will be
received by, or allocated to, our CEO, other named executive officers and
current directors under the Directors Plan for 2002:

[Enlarge/Download Table]

NAME DOLLAR VALUE NUMBER OF UNITS
---- ------------ ---------------

Paul A. Ricci............................................. -- --
Michael K. Tivnan......................................... -- --
Wayne S. Crandall......................................... -- --
Richard S. Palmer......................................... -- --
Ben S. Wittner............................................ -- --
Executive Group........................................... -- --
Non-Executive Director Group.............................. $333,750 75,000
Non-Executive Officer Employee Group...................... -- --

1997 Employee Stock Option Plan

Our 1997 Employee Stock Option Plan (the "1997 Plan") became effective on
January 1, 1997 and was last amended by our board effective June, 2000.

General. The 1997 Plan provides for the granting of nonstatutory stock
options within the meaning of Section 422 of the Code. As of December 31, 2002,
312,476 shares had been issued upon exercise of options granted under the 1997
Plan, options to purchase 908,030 shares were outstanding, and 79,494 shares
remained available for future grant. As of December 31, 2002, the fair market
value of all shares of common stock subject to outstanding options was
$4,721,756, based on the closing sale price of $5.20 for our common stock as
reported on the Nasdaq National Market on December 31, 2002. As of December 31,
2002, (i) options to purchase 164,667 shares of common stock were outstanding
under the Plan and held by all current executive officers as a group (3
persons), (ii) options to purchase 20,000 shares were outstanding under the Plan
and held by current directors (one person) who are not executive officers and
(iii) options to purchase 723,363 shares of common stock were outstanding and
held by employees, including current officers who are not executive officers,
and consultants.

Purpose. The purposes of the 1997 Plan are to attract and retain the best
available personnel for positions of substantial responsibility, to provide
additional incentive to our employees and consultants and to promote the success
of the our business.

Administration. The 1997 Plan may be administered by our board or by a
committee designated by our board (the "Administrator"); it is currently
administered by our board and the compensation committee of the board. Members
of the board receive no additional compensation for their services in connection
with the administration of the 1997 Plan. All questions of interpretation of the
Plan are determined by the Administrator, and decisions of the Administrator are
final and binding upon all participants.

Eligibility. The 1997 Plan provides that options may be granted to our
employees and consultants. For the purposes of the 1997 Plan, officers, named
executive officers and directors are not considered employees and are not
eligible to receive grants under the 1997 Plan unless they fall under a special
exception. The exception is that officers who are not previously employed by us
and for whom an option grant is an essential inducement for the officer to join
us may be treated as an employee for purposes of receiving a grant under the
1997 Plan. As of December 31, 2002, we had approximately 489 employees, seven
directors (including two employee directors), and 24 consultants. The
Administrator, in its discretion, selects the employees and consultants to whom
options may be granted, the time or times at which such options are granted, and
the exercise price (within the limits described below) and number of shares
subject to each such grant.

424B1 63rd Page of 174 TOC 1st Previous Next ↓Bottom Just 63rd
Terms of Options. The terms of options granted under the 1997 Plan are
determined by the Administrator. Each option is evidenced by a stock option
agreement between us and the optionee and is subject to, among other things, the
following terms and conditions:

(a) Exercise of the Option. The optionee must earn the right to
exercise the option by continuing to work for us. The Administrator
determines when options are exercisable. An option is exercised by giving
written notice of exercise to us specifying the number of full shares of
common stock to be purchased, and by tendering payment of the purchase
price to us. The method of payment of the exercise price of the shares
purchased upon exercise of an option is determined by the Administrator.

(b) Exercise Price. The Administrator determines the exercise price
of options at the time the options are granted. The exercise price of a
stock option may not be less than 100% of the fair market value of the
common stock on the date such option is granted. The fair market value of
the common stock is generally determined with reference to the closing
sales price for the common stock (or the closing bid if no sales were
reported) on the date the option is granted.

We may not: reduce the exercise price of any stock option outstanding
or to be granted in the future under the 1997 Plan; cancel and re-grant
options at a lower exercise price (including entering into any "6 month and
1 day" cancellation and re-grant scheme), whether or not the cancelled
options are put back into the available pool for grant; replace underwater
options with restricted stock in an exchange, buy-back or other scheme; or
replace any options with new options having a lower exercise price or
accelerated vesting schedule in an exchange, buy-back or other scheme.

(c) Termination of Employment. If the optionee's employment or
consulting relationship with us is terminated for any reason other than
death or total and permanent disability, options under the 1997 Plan may be
exercised not later than thirty days (or such other period of time not
exceeding the expiration of the term of the option, as determined by the
Administrator) after the date of such termination to the extent the option
was exercisable on the date of such termination. In no event may an option
be exercised by any person after the expiration of its term.

(d) Termination of Options. Nonstatutory options granted under the
1997 Plan expire ten years from the date of grant unless a shorter period
is provided in the option agreement.

(e) Nontransferability of Options. Generally, options under the 1997
Plan are nontransferable by the optionee, other than by will or the laws of
descent and distribution, and are exercisable only by the optionee during
his or her lifetime. However, the Administrator may, in its discretion,
grant transferable nonstatutory stock options pursuant to option agreements
specifying (i) the manner in which the nonstatutory options are
transferable and (ii) that any such transfer be subject to applicable law.

(f) Effect of Corporate Transactions. In the event of our proposed
dissolution or liquidation, the options under the 1997 Plan will terminate
immediately prior to the consummation of the proposed action, unless
otherwise provided by the Administrator. The Administrator may, in the
exercise of its sole discretion in such instances, declare that any option
be terminated as of a date fixed by the Administrator and give each
optionee the right to exercise the optionee's option as to all or any part
of the option, including shares as to which the option would not otherwise
be exercisable. In the event of a sale of all or substantially all of our
assets, or our merger with another corporation, an option granted under the
1997 Plan will be assumed or an equivalent option will be substituted by
the successor corporation or a parent or subsidiary of the successor
corporation. If the successor corporation does not assume or provide
substitute options, the Administrator will make provisions for the
acceleration of the optionee's right to exercise his or her outstanding
options in full. If the Administrator makes an option fully exercisable in
lieu of assumption or substitution in the event of a merger or sale of
assets, the Administrator will notify the optionee that the option will be
fully exercisable for a period of 15 days from the date of the notice, and
the option will terminate upon the expiration of such period.

424B1 64th Page of 174 TOC 1st Previous Next ↓Bottom Just 64th
Amendment and Termination. Our board may terminate the 1997 Plan, or may
amend the 1997 Plan from time to time in any respect, as it feels advisable. The
1997 Plan will terminate in January, 2007, but any options then outstanding
under the 1997 Plan will remain outstanding until they expire by their terms.

1998 Stock Option Plan

Our 1998 Stock Option Plan (the "1998 Plan") was assumed by us upon the
consummation of the merger between Visioneer, Inc. and Scansoft, Inc. on March
12, 1999. As of December 31, 2002, there were outstanding options to purchase
919,081 shares of common stock under the 1998 Plan, with exercise prices ranging
from $0.6100 to $1.3438 per share. As of December 31, 2002, there were no shares
available for future grants.

General. The purpose of the 1998 Plan is to obtain and retain the services
of the types of employees, consultants, officers and directors who will
contribute to our long range success and to provide incentives which are linked
directly to increases in share value which will benefit all of our stockholders.
Options granted under the 1998 Plan may be either "incentive stock options" or
nonstatutory stock options. However, only officers and employees are eligible to
be granted incentive stock options.

Administration. The 1998 Plan may be administered by our Board or a
committee appointed by our Board (as applicable, the "Administrator"). The
Administrator may make any determinations deemed necessary or advisable for the
1998 Plan.

Eligibility. Directors, officers, employees and consultants who, as
determined by the Administrator, are responsible for or contribute to the
management, growth or profitability of our business may be granted stock options
under the 1998 Plan. However, only officers and employees may be granted
incentive stock options. As of December 31, 2002, we had approximately 489
employees, seven directors (including two employee directors), and 24
consultants. The Administrator, in its discretion, selects the directors,
officers, employees and consultants to whom options may be granted, the time or
times at which such options are granted, and the exercise price (within the
limits described below) and number of shares subject to each such grant.

Limitations. The 1998 Plan provides that no one may be granted, during any
one year period, options to purchase more than 1,000,000 shares of our common
stock.

Terms and Conditions of Options. Each option is evidenced by a stock
option agreement between us and the optionee, and is subject to the following
terms and conditions:

(a) Exercise Price. The Administrator determines the exercise price
of options at the time the options are granted. The exercise price for
incentive stock options may not be less than 100% of the fair market value
of the shares of stock on the grant date. In the case of nonstatutory
options, the exercise price may be determined in the sole discretion of the
Administrator, provided, that the exercise price may not be less than 85%
of the fair market value of the shares of stock on the grant date of the
nonstatutory option. In the case of either an incentive stock option or a
nonstatutory option granted to a 10% stockholder, the exercise price may
not be less than 110% of the fair market value. The fair market value of
our common stock is generally determined with reference to the closing sale
price for the common stock on the last market trading day prior to the date
the option is granted.

(b) Exercise of Option; Form of Consideration. The Administrator
determines when options become exercisable, and may in its discretion,
accelerate the vesting of any outstanding option. The 1998 Plan provides
that options granted under the 1998 Plan must vest at a rate of at least
20% per year over a period of five years from the grant date, unless a
lower vesting rate or longer vesting period is permitted by applicable law
or regulation. In the case of an incentive stock option granted to a 10%
stockholder, the vesting or exercise period may not exceed five years from
the grant date. The 1998 Plan provides that the exercise price must be paid
in full at the time of exercise in cash.

424B1 65th Page of 174 TOC 1st Previous Next ↓Bottom Just 65th
(c) Term of Option. The term of an incentive stock option may be no
more than ten years from the grant date; provided, however, that in the
case of an incentive stock option granted to a 10% stockholder, the term of
the option may be no more than five years from the date of grant. No option
may be exercised after the expiration of its term.

(d) Termination of Service. If an optionee's service relationship
terminates for any reason, then the optionee generally may exercise the
option within 80 days of such termination, to the extent that the option is
vested on the date of termination (but in no event later than the
expiration of the term of such option as set forth in the option
agreement).

(e) Nontransferability of Options. Unless otherwise determined by the
Administrator, options granted under the 1998 Plan are not transferable
other than by will or the laws of descent and distribution, and may be
exercised during the optionee's lifetime only by the optionee or by the
optionee's guardian or legal representative.

(f) Other Provisions. The stock option agreement may contain other
terms, provisions and conditions not inconsistent with the 1998 Plan as may
be determined by the Administrator.

Adjustments Upon Changes in Capitalization. In the event that our stock
changes by reason of any stock split, reverse stock split, stock dividend,
recapitalization, combination or reclassification in our capital structure,
appropriate adjustments shall be made in the number and class of shares of stock
subject to the 1998 Plan, the number and class of shares of stock subject to any
option outstanding under the 1998 Plan, and the exercise price of any such
outstanding option or stock purchase right.

In the event of a liquidation or dissolution, the Administrator may provide
that the holder of any option then exercisable have the right to exercise that
option subsequent to the liquidation or dissolution, and for the balance of its
term, solely for the kind and amount of shares of stock and other securities,
cash or other property receivable upon such liquidation or dissolution by a
holder of the number of shares of stock for which the option might have been
exercised immediately prior to the liquidation or dissolution. The Administrator
may also provide, in the alternative, that each option granted under the 1998
Plan terminate as of a date to be fixed by the Board provided that written
notice is given to each optionee at least 30 days prior to the termination date.
Each option holder then has the right, during the 30 days preceding the option
termination, to exercise the option as to all or any part of the shares of stock
covered by the option, to the extent that the option is then exercisable.

In the case of any capital reorganization, any reclassification of the
common stock (other than a change in par value or recapitalization), or the
consolidation of our company with, or a sale of substantially all of our assets
(which sale is followed by our liquidation or dissolution), or merger of our
company with another person (a "Reorganization Event"), the Administrator is to
determine whether the Reorganization Event constitutes a liquidation or
dissolution and to deliver to optionees at least 15 days prior to the
Reorganization Event a notice which (i) indicates whether the Reorganization
Event is a liquidation or dissolution, and (ii) advises the optionee of his or
her rights pursuant to the stock option agreement.

If the Reorganization Event is determined to be a liquidation or
dissolution, in its sole and absolute discretion, the surviving corporation may,
but is not be obligated to, (i) tender stock options to the optionee with
respect to the surviving corporation which contains terms and provisions that
substantially preserve the rights and benefits of the optionee, and (ii) in the
event that no stock options have been tendered by the surviving corporation, the
optionee has the right exercisable during a 10-day period ending on the fifth
day prior to the Reorganization Event to exercise his or her options, to the
extent that such options are then exercisable.

If the Reorganization Event is not determined to be a liquidation or
dissolution, the optionee is entitled upon exercise of the option to purchase
the kind and number of shares of stock or other securities, cash or other
property of the surviving corporation receivable upon such event by a holder of
the number of shares of the common stock which the option entitles the optionee
to purchase from us immediately prior to such event. In the case of any
Reorganization Event that is a reorganization, merger or
63

424B1 66th Page of 174 TOC 1st Previous Next ↓Bottom Just 66th
consolidation in which we are not the surviving corporation, the Administrator
may, in its sole and absolute discretion, accelerate the vesting period of the
options.

Amendment and Termination of the Plan. The Board may amend, alter, or
discontinue the 1998 Plan. However, we must obtain stockholder approval for any
amendment to the 1998 Plan which would: (i) increase the total number of shares
of stock reserved for the purposes of the 1998 Plan; (ii) materially increase
the benefits accruing to eligible persons under the 1998 Plan; or (iii)
materially modify the requirements for eligibility under the 1998 Plan. No such
action by the Board or stockholders may alter or impair any option previously
granted under the 1998 Plan without the written consent of the optionee. No
options may be granted under the 1998 Plan on or after December 31, 2002.

2000 Stock Plan

Our 2000 Stock Plan (the "2000 Plan") was adopted by our board and approved
by our stockholders in May, 2000, and was last amended by the board on April 5,
2002 and by the stockholders on June 14, 2002. As of December 31, 2002, there
were options to purchase 2,612,837 shares of common stock under the Plan, with
exercise prices ranging from $1.2813 to $6.97 per share. In addition, as of the
same date, there were available for future grant options to purchase 1,701,113
shares of common stock.

General. The purpose of the 2000 Plan is to attract and retain the best
available personnel for positions of substantial responsibility with our
company, to provide additional incentive to our employees and consultants and to
promote the success of our business. Options granted under the 2000 Plan may be
either incentive stock options or nonstatutory stock options. Stock purchase
rights may also be granted under the Plan.

Administration. The 2000 Plan generally may be administered by the board
or a committee appointed by the board (as applicable, the "Administrator"). The
Administrator may make any determinations deemed necessary or advisable for the
2000 Plan.

Eligibility. Nonstatutory stock options and stock purchase rights may be
granted under the 2000 Plan to our employees, directors and consultants. As of
December 31, 2002, we had approximately 489 employees, seven directors
(including two employee directors), and 24 consultants. Incentive stock options
may be granted only to employees. The Administrator, in its discretion, selects
the employees, directors and consultants to whom options and stock purchase
rights may be granted, the time or times at which such options and stock
purchase rights shall be granted, and the exercise price and number of shares
subject to each such grant; provided, however, the exercise price of a stock
option may not be less than 100% of the fair market value of the common stock on
the date such option is granted.

Limitations. Section 162(m) of the Code places limits on the deductibility
for federal income tax purposes of compensation paid to certain of our executive
officers. In order to preserve our ability to deduct the compensation income
associated with options granted to such persons, the 2000 Plan provides that no
employee may be granted, in any fiscal year, options or stock purchase rights to
purchase more than 750,000 shares of common stock. Notwithstanding this limit,
however, in connection with such individual's initial employment with us, he or
she may be granted options or stock purchase rights to purchase up to an
additional 750,000 shares of common stock.

Terms and Conditions of Options. Each option is evidenced by a stock
option agreement between us and the optionee, and is subject to the following
terms and conditions:

(a) Exercise Price. The Administrator determines the exercise price
of options at the time the options are granted. The exercise price of a
stock option may not be less than 100% of the fair market value of the
common stock on the date such option is granted; provided, however, that
the exercise price of an incentive stock option granted to a 10%
stockholder may not be less than 110% of the fair market value on the date
such option is granted. The fair market value of the common stock is
generally determined with reference to the closing sale price for the
common stock (or the closing bid if no sales were reported) on the last
market trading day prior to the date the option is granted.

424B1 67th Page of 174 TOC 1st Previous Next ↓Bottom Just 67th
We may not: reduce the exercise price of any stock option, including
stock appreciation right, outstanding or to be granted in the future under
the 2000 Plan; cancel and re-grant options at a lower exercise price
(including entering into any "6 month and 1 day" cancellation and re-grant
scheme), whether or not the cancelled options are put back into the
available pool for grant; replace underwater options with restricted stock
in an exchange, buy-back or other scheme; or replace any options with new
options having a lower exercise price or accelerated vesting schedule in an
exchange, buy-back or other scheme.

(b) Exercise of Option; Form of Consideration. The Administrator
determines when options become exercisable, and may in its discretion,
accelerate the vesting of any outstanding option. The means of payment for
shares issued upon exercise of an option is specified in each option
agreement. The 2000 Plan permits payment to be made by cash, check,
promissory note, other shares of our common stock (with some restrictions),
cashless exercises, any other form of consideration permitted by applicable
law, or any combination thereof.

(c) Term of Option. The term of an incentive stock option may be no
more than ten years from the date of grant; provided, however, that in the
case of an incentive stock option granted to a 10% stockholder, the term of
the option may be no more than five years from the date of grant. No option
may be exercised after the expiration of its term.

(d) Termination of Service. If an optionee's service relationship
terminates for any reason (excluding death or disability), then the
optionee generally may exercise the option within 90 days of such
termination or within such time period as specified in the option
agreement, to the extent that the option is vested on the date of
termination, (but in no event later than the expiration of the term of such
option as set forth in the option agreement). If an optionee's service
relationship terminates due to the optionee's disability, the optionee
generally may exercise the option, to the extent the option was vested on
the date of termination, within 12 months, or as specified in the option
agreement, from the date of such termination. If an optionee's service
relationship terminates due to the optionee's death, the optionee's estate
or the person who acquires the right to exercise the option by bequest or
inheritance generally may exercise the option, as to the vested shares
subject to the option (not including unvested shares), within 12 months
from the date of such termination or as defined in the option agreement.

(e) Nontransferability of Options. Unless otherwise determined by the
Administrator, options granted under the 2000 Plan are not transferable
other than by will or the laws of descent and distribution, and may be
exercised during the optionee's lifetime only by the optionee.

(f) Other Provisions. The stock option agreement may contain other
terms, provisions and conditions not inconsistent with the 2000 Plan as may
be determined by the Administrator.

Stock Purchase Rights. In the case of stock purchase rights, unless the
Administrator determines otherwise, the restricted stock purchase agreement
shall grant us a repurchase option exercisable upon the voluntary or involuntary
termination of the purchaser's employment with us for any reason (including
death or disability). The purchase price for shares repurchased pursuant to the
restricted stock purchase agreement shall be the original price paid by the
purchaser and may be paid by cancellation of any indebtedness of the purchaser
to us. The repurchase option shall lapse at a rate determined by the
Administrator.

Adjustments Upon Certain Corporate Transactions. In connection with any
merger of our company with or into another corporation or the sale of all or
substantially all of our assets, each outstanding option and stock purchase
right shall be assumed or an equivalent option or right substituted by the
successor corporation. If the successor corporation refuses to assume the
options or rights or to substitute substantially equivalent options or rights,
the optionee shall have the right to exercise the option or stock purchase right
as to all the optioned stock, including shares not otherwise vested or
exercisable. In such event, the Administrator shall notify the optionee that the
option or stock purchase right is fully

424B1 68th Page of 174 TOC 1st Previous Next ↓Bottom Just 68th
exercisable for fifteen days from the date of such notice and that the option
terminates upon expiration of such period.

Amendment and Termination of the Plan. The board may amend, alter, suspend
or terminate the 2000 Plan, or any part thereof, at any time and for any reason.
Unless terminated earlier, the 2000 Plan shall terminate ten years from the date
the 2000 Plan or any amendment to add shares to the 2000 Plan was last adopted
by the board.

Plan Benefits. The amount and timing of options and awards granted under
the 2000 Plan are determined in the sole discretion of the Administrator. As a
result, the benefits or amounts that will be received by, or allocated to, our
CEO, our other named executive officers and our current directors under the 2000
Plan for 2003 are not determinable. However, the following sets forth the
options or awards granted to such persons in fiscal year 2002. Amounts granted
in 2002 may not be representative of amounts granted in the future.

[Enlarge/Download Table]

NAME DOLLAR VALUE NUMBER OF UNITS
---- ------------ ---------------

Paul A. Ricci............................................. $5,878,429 961,554
Michael K. Tivnan......................................... $ 122,840 22,918
Wayne S. Crandall......................................... $ 697,000 100,000
Richard S. Palmer......................................... -- --
Robert Weideman........................................... -- --
Ben S. Wittner............................................ $ 12,667 67,895
Executive Group........................................... $6,710,936 1,152,367
Non-Executive Director Group.............................. -- --
Non-Executive Officer Employee Group...................... -- --

401(K) RETIREMENT PLAN

The 401(k) plan provides that each participant may contribute up to 15% of
his or her pre-tax gross compensation up to the statutory limit, which was
$10,500 in calendar year 2001. Through October 15, 2002, we provided a match of
an employee's contributions dollar for dollar up to 4%. For example, if an
employee contributed 6% we matched at 4%; if the employee contributed 4% we
matched the 4%; if the employee contributed 2% we matched the 2%, and so on.
Employees are 100% vested into the plan as soon as they start to contribute to
the plan. Effective October 16, 2002, this match was discontinued.

LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION

Our certificate of incorporation provides that our directors will not be
personally liable to us or our stockholders for monetary damages for breach of
their fiduciary duties as directors, except liability for any of the following:

- any breach of their duty of loyalty to the corporation or its
stockholders;

- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;

- payments of dividends or approval of stock repurchases or redemptions
that are prohibited by Delaware law; or

- any transaction from which the director derived an improper personal
benefit.

This limitation of liability does not apply to liabilities arising under
the federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.

Our certificate of incorporation and bylaws provide that we shall indemnify
our directors, officers, employees and other agents to the fullest extent
permitted by law. We believe that indemnification under our bylaws covers at
least negligence and gross negligence on the part of indemnified parties. Our
bylaws

424B1 69th Page of 174 TOC 1st Previous Next ↓Bottom Just 69th
also permit us to secure insurance on behalf of any officer, director, employee
or other agent for any liability arising out of his or her actions in such
capacity, regardless of whether Delaware law would permit indemnification.

We have entered into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our certificate of
incorporation and bylaws. These agreements, among other things, provide for
indemnification of our directors and officers for expenses, judgments, fines,
penalties and settlement amounts incurred by any such person in any action or
proceeding arising out of such person's services as a director or officer or at
our request.

We believe that these provisions and agreements are necessary to attract
and retain qualified persons as directors and executive officers. There is no
pending litigation or proceeding involving any of our directors, officers,
employees or agents. We are not aware of any pending or threatened litigation or
proceeding that might result in a claim for indemnification by a director,
officer, employee or agent.

424B1 70th Page of 174 TOC 1st Previous Next ↓Bottom Just 70th
CERTAIN RELATIONSHIPS AND SECURITIES TRANSACTIONS

RELATED PARTY TRANSACTIONS

At December 31, 2002, Xerox owned approximately 18.7% of our outstanding
common stock and all of our outstanding Series B Preferred Stock. In connection
with our acquisition of ScanSoft in 1999 (following which we renamed ourselves
ScanSoft), we issued 3,562,238 shares of Series B Preferred Stock to Xerox. The
Series B Preferred Stock is convertible into shares of common stock on a share
for share basis. The Series B Preferred Stock has a liquidation preference of
$1.30 per share plus all declared but unpaid dividends. The Series B Preferred
Stockholders are entitled to non-cumulative dividends at the rate of $0.05 per
annum per share, payable when, as and if declared by the Board of Directors. To
date no dividends have been declared by the Board of Directors. Holders of
Series B Preferred Stock have no voting rights, except those rights provided
under Delaware law. See "Description of Capital Stock" below for a discussion of
the rights, preferences, privileges and restrictions of our Series B Preferred
Stock.

In addition, Xerox has the opportunity to acquire additional shares of
common stock pursuant to a ten-year warrant. The warrant allows Xerox to acquire
a number of shares of common stock equal to the number of options (whether
vested or unvested) that remain unexercised at the expiration of any ScanSoft
option assumed by us in the merger. The exercise price for each warrant share is
$0.61. If all of the assumed ScanSoft options expire without being exercised,
Xerox would be entitled to purchase 1,736,630 shares of common stock. The
warrant was fully vested on the date of grant; however, Xerox could not exercise
the warrant prior to March 2, 2002, unless, immediately after such exercise,
Xerox owned directly or indirectly less than 45% of the shares of our common
stock outstanding immediately after such exercise. From the date of acquisition
through December 31, 2002, approximately 525,732 ScanSoft options have been
forfeited. Accordingly, Xerox had the opportunity to acquire up to a maximum of
525,732 shares of our common stock as of December 31, 2002.

We and Xerox have entered into three non-exclusive agreements in which we
granted Xerox the royalty-bearing right to copy and distribute certain of our
software programs with Xerox's multi-function peripherals. All agreements were
negotiated on an arm's length basis, and the royalties and other economic terms
are comparable with our other OEM agreements.

On June 29, 1998, we and Xerox entered into a Gold Disk Bundling Agreement,
wherein we granted to Xerox a non-exclusive license to bundle and distribute
certain of our software products with Xerox's document system products for the
small office and home office market. Under this agreement, as amended, Xerox
paid us $0.5 million in non-refundable advances representing pre-paid royalties
on the licensed software. We recorded revenue totaling $1.8 million, $2.4
million and $0.5 million for the years ended December 31, 2001, 2000 and 1999
respectively, under this agreement. On June 14, 2001 Xerox announced its exit
from the small office/home office business segment, therefore, revenue for the
nine months ended September 30, 2002 was zero.

On March 25, 1998, we and Xerox entered into a Gold Disk Bundling
Agreement, wherein we granted to Xerox a non-exclusive license to bundle and
distribute certain of our software with Xerox's large corporate multifunction
devices for more than 25 users. On September 30, 1999, we and Xerox entered into
a Gold Disk Bundling Agreement, wherein we granted to Xerox a non-exclusive
license to bundle and distribute certain of our software with Xerox's large
corporate multifunction devices and document center systems. Under this
agreement, which superseded the March 25, 1998 Agreement, Xerox agreed to pay us
a one-time non-refundable license fee of $0.6 million, in addition to royalties
on the licensed software. Under these two agreements, we recorded revenue
totaling $5.4 million, $3.4 million and $4.2 million for the years ended
December 31, 2001, 2000 and 1999 respectively. For the nine months ended
September 30, 2002, we recorded revenue totaling $3.6 million.

In total, Xerox accounted for $7.2 million, $5.9 million and $4.7 million
of our revenue for the years ended December 31, 2001, 2000 and 1999
respectively, accounting for 11%, 11% and 14% of our total revenue,
respectively. For the nine months ended September 30, 2002, Xerox accounted for
revenue of $3.6 million or 5% of total revenue. During 2001, Xerox paid us $7.0
million under these agreements, and
68

424B1 71st Page of 174 TOC 1st Previous Next ↓Bottom Just 71st
as of December 31, 2001, Xerox owed us $1.8 million. For the first nine months
of 2002, Xerox paid us $4.0 million under these agreements and as of September
30, 2002, Xerox owed us $1.2 million.

We believe that the terms under the June 29, 1998, March 25, 1998 and
September 30, 1999 agreements were no more favorable than those we would have
negotiated with unrelated parties.

The law firm of Wilson Sonsini Goodrich & Rosati, Professional Corporation
acts as our primary outside corporate and securities counsel. Ms. Martin, one of
our directors, and the owner of record of 1,000 shares of our common stock and
95,000 options to purchase shares of our common stock, is a member of Wilson
Sonsini Goodrich & Rosati. As such, Ms. Martin is contractually obligated to
transfer a portion of these options to a fund for the benefit of all members of
Wilson Sonsini Goodrich & Rosati. Aggregate fees and costs billed to us during
the 12 months ended December 31, 2002 by Wilson Sonsini Goodrich & Rosati were
approximately $1.5 million. We believe that the services performed by Wilson
Sonsini Goodrich & Rosati were provided to us on terms no less favorable than
those provided to us by unrelated parties.

SECURITIES TRANSACTIONS

On September 13, 1999, we purchased 600,000 shares of Series A Preferred
Stock at a cost of $0.25 per share for a total investment of $150,000 in
BookmarkCentral.com (which was recently renamed EchoBahn.com, Inc.). One of our
former directors is a founder and the current President and Chief Executive
Officer of EchoBahn. During 2001, the Company wrote-off its investment in
EchoBahn after determining that the investment was impaired. We accounted for
the investment under the cost basis method of accounting.

In September 2002, we repurchased 1,461,378 shares of common stock from L&H
and certain other parties for $7.0 million. These shares represented a portion
of the common shares that we issued to the selling stockholders in connection
with our December 12, 2001 acquisition of certain of L&H's speech and language
technology operations and our March 21, 2002 acquisition of the AudioMining
assets of L&H Holdings USA, Inc. We agreed to issue 150,000 shares of our common
stock to the selling stockholders if we do not complete an underwritten public
offering for the selling stockholders by December 15, 2002. To fulfill this
obligation, on December 18, 2002, we issued 81,900 shares to Lernout & Hauspie
Speech Products, N.V. and 68,100 shares to L&H Holdings USA, Inc. We further
agreed to issue an additional 150,000 shares of our common stock to the selling
stockholders if we do not complete an underwritten public offering for the
selling stockholders by February 15, 2003. We also will be required to issue an
additional 100,000 shares of our common stock to L&H if, by February 15, 2003,
we fail to file a registration statement to register the shares remaining
unsold, if any, after this offering. Additionally, if the consummation of this
offering does not occur by January 1, 2003, the outstanding principal and
interest under the $3.5 million promissory note, dated December 12, 2001, that
we issued in connection with the acquisition of L&H's speech and language
technologies business would become immediately due and payable. To fulfill this
obligation, on January 3, 2003, we paid $3.3 million in full settlement of all
of the outstanding principal and accrued interest under this note.

In connection with the Philips acquisition, in January 2003 we issued to
Philips a $27.5 million three-year, zero-interest convertible subordinate
debenture. This debenture is convertible into shares of our common stock at any
time at the option of Philips at a conversion price of $6.00 per share. We also
issued a note to Philips with a principal amount of euro 5 million due December
31, 2003 and bearing 5.0% interest per annum.

424B1 72nd Page of 174 TOC 1st Previous Next ↓Bottom Just 72nd
PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth information with respect to the beneficial
ownership of our common stock as of December 31, 2002, as to:

- each person (or group of affiliated persons) who is known by us to
beneficially own more than 5% of our common stock;

- each of our directors;

- each officer named in the Summary Compensation Table; and

- all of our current directors and executive officers as a group.

The information has been adjusted to reflect the sale of our common stock
in this offering. The information assumes no exercise of the underwriters'
over-allotment option.

Beneficial ownership is determined in accordance with SEC rules and
includes voting or investment power with respect to securities. All shares of
common stock subject to options exercisable within 60 days of December 31, 2002
are deemed to be outstanding and beneficially owned by the persons holding those
options for the purpose of computing the number of shares beneficially owned and
the percentage ownership of that person. They are not, however, deemed to be
outstanding and beneficially owned for the purpose of computing the percentage
ownership of any other person.

Subject to the paragraph above, percentage ownership of outstanding shares
is based on 63,422,776 shares of common stock outstanding as of December 31,
2002. Percentage ownership after offering reflects an additional 1,000,000
shares to be sold by us in this offering.

[Enlarge/Download Table]

PERCENTAGE OF
NUMBER OF BENEFICIAL
NUMBER OF SHARES OWNERSHIP
SHARES NUMBER OF BENEFICIALLY -------------------
BENEFICIALLY SHARES BEING OWNED AFTER BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED SOLD OFFERING OFFERING OFFERING
--------------------------------------- ------------ ------------ ------------ -------- --------

5% STOCKHOLDERS:
Xerox Corporation.................... 15,941,572(2) -- 15,941,572(2) 23.6% 23.3%
800 Long Ridge Road
Stamford, CT 06904
State of Wisconsin Investment Board... 11,735,000 -- 11,735,000 18.5% 18.2%
P.O. Box 7842
Madison, WI 53707
Lernout & Hauspie Speech Products
N.V.(3)............................ 4,122,300 4,122,300 -- 6.5% --
Flanders Language Valley 50
8900 Ieper, Belgium
L&H Holdings USA, Inc.(3)............ 2,062,106 2,062,106 -- 3.3% --
52 Third Avenue
Burlington, MA. 01803
DIRECTORS AND OFFICERS:
Paul A. Ricci(4)..................... 3,065,720 -- 3,065,720 4.6% 4.6%
Michael K. Tivnan(5)................. 1,019,854 -- 1,019,854 1.7% 1.7%
Mark B. Myers(6)..................... 80,000 -- 80,000 * *
Katharine A. Martin(7)............... 96,000 -- 96,000 * *
Robert G. Teresi(8).................. 242,186 -- 242,186 * *
Robert J. Frankenberg(9)............. 211,708 -- 211,708 * *
Wayne S. Crandall(10)................ 554,010 -- 554,010 * *
Richard S. Palmer(11)................ 587,500 -- 587,500 * *

424B1 73rd Page of 174 TOC 1st Previous Next ↓Bottom Just 73rd
[Enlarge/Download Table]

Ben S. Wittner(12)................... 347,662 -- 347,662 * *
All directors and executive officers as
a group (10 persons)(13)........... 6,513,744 -- 6,513,744 9.4% 9.3%

---------------

* Less than 1%.

(1) Unless otherwise indicated, the address for the following stockholders is
c/o ScanSoft, Inc., 9 Centennial Drive, Peabody, Massachusetts 01960.

(2) Includes a warrant that as of December 31, 2002 was exercisable for up to
525,732 shares of our common stock, and 3,562,238 shares of non-voting
Series B Preferred Stock. The shares that underlie this warrant and the
Series B shares have not been converted into common stock and are factored
into the calculation of Xerox's beneficial ownership only for the purposes
of this table. As of December 31, 2002, Xerox owned 11,853,602 shares of
our common stock. All of these securities are owned of record by Xerox
Imaging Systems, Inc., a wholly-owned subsidiary of Xerox Corporation.

(3) Of the 6,184,406 shares listed above, 4,122,300 are held of record by
Lernout & Hauspie Speech Products N.V., and 2,062,106 are held of record by
L&H Holdings USA, Inc. All of these shares are being offered for sale
pursuant to this prospectus. Investment and voting control over these
shares is held by Allan Forsey and Jean-Marc Vanstaen subject, under
certain circumstances, to bankruptcy court approval. Mr. Forsey is the Plan
Administrator for L&H Holdings USA, Inc. and Mr. Vanstaen is a curator on
behalf of Lernout & Hauspie Speech Products N.V. For further information,
see "Certain Relationships and Securities Transactions."

(4) Includes options to acquire 2,910,720 shares of our common stock that are
exercisable through March 1, 2003.

(5) Includes options to acquire 1,019,854 shares of our common stock that are
exercisable through March 1, 2003.

(6) Represents options to acquire shares of our common stock that are
exercisable through March 1, 2003.

(7) Includes options to acquire 95,000 shares of our common stock that are
exercisable through March 1, 2003.

(8) Includes options to acquire 70,000 shares of our common stock that are
exercisable through March 1, 2003.

(9) Represents options to acquire shares of our common stock that are
exercisable through March 1, 2003.

(10) Includes options to acquire 526,010 shares of our common stock that are
exercisable through March 1, 2003.

(11) Includes 75,000 shares of restricted stock with a 2 1/2 year cliff vesting,
which vest 100% on April 17, 2004, and options to acquire 510,500 shares of
our common stock that are exercisable through March 1, 2003.

(12) Includes options to acquire 343,254 shares of our common stock that are
exercisable through March 1, 2003.

(13) Includes 75,000 shares of restricted stock issued to Mr. Palmer (see note
11 above); 58,824, of which 19,608 was released, shares of restricted stock
issued to Mr. Weideman, restrictions on which will lapse 1/3 on each
anniversary date of grant; and options to acquire 5,933,796 shares of our
common stock that are exercisable through March 1, 2003.

424B1 74th Page of 174 TOC 1st Previous Next ↓Bottom Just 74th
DESCRIPTION OF CAPITAL STOCK

The following description of our capital stock is qualified in its entirety
by the provisions of our amended and restated certificate of incorporation and
bylaws, which have been incorporated by reference into Part II of the
Registration Statement.

AUTHORIZED AND OUTSTANDING CAPITAL STOCK

Our charter provides that we are authorized to issue 140,000,000 shares of
common stock, $0.001 par value per share, and 40,000,000 shares of preferred
stock, $0.001 par value per share. As of December 31, 2002, there were
outstanding 63,422,776 shares of common stock held by approximately 566
stockholders of record, and 3,562,238 shares of Series B preferred stock held by
Xerox. As of December 31, 2002, there were no shares of Series A preferred stock
outstanding.

COMMON STOCK

The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock (see "Preferred Stock" below), the
holders of common stock are entitled to receive such dividends, if any, as may
be declared from time to time by our board out of legally available funds. In
the event of a liquidation, dissolution or winding up of our company, the
holders of common stock are entitled to share ratably in all assets remaining
after payment of liabilities, subject to prior rights of the preferred stock.
The common stock has no preemptive or conversion rights or other subscription
rights. There are no redemption or sinking fund provisions available to the
common stock. The rights, preferences, and privileges of holders of the common
stock are subject to, and may be adversely affected by, the rights of holders of
shares of our preferred stock, as discussed below.

PREFERRED STOCK

Our board may issue preferred stock in different series and classes and fix
the dividend rights, dividend rate, conversion rights, voting rights, rights and
terms of redemption (including sinking fund provisions), liquidation
preferences, and other rights and preferences of preferred stock not in conflict
with our charter or Delaware law.

Our charter currently designates two series of preferred stock: the Series
A Participating Preferred Stock consisting of 100,000 shares and the Series B
Preferred Stock consisting of 15,000,000 shares. Our preferred stock may have
the effect of delaying, deferring or preventing a change in control of our
company without further action by the stockholders (see "Anti-Takeover
Provisions below). Additionally, the issuance of preferred stock may adversely
affect the rights of the holders of common stock as follows:

- Dividends. Our preferred stock is entitled to receive dividends out of
any legally available assets, when and if declared by our board prior and
in preference to any declaration or payment of any dividend on the common
stock. In addition, after the first issuance of the Series A
Participating Preferred Stock, we cannot declare a dividend or make any
distribution on the common stock unless we concurrently declare a
dividend on such Series A Participating Preferred Stock. Moreover, we
cannot pay dividends or make any distribution on the common stock as long
as dividends payable to the Series A Participating Preferred Stock are in
arrears. With respect to the Series B Preferred Stock, we cannot declare
a dividend or make any distribution on the common stock unless full
dividends on the Series B Preferred Stock have been paid or declared and
the sum sufficient for the payment set apart.

- Voting Rights. Each share of Series A Participating Preferred Stock
entitles its holder to 1,000 votes on all matters submitted to a vote of
our stockholders. In addition, the Series A Participating Preferred and
the common stock holders vote together as one class on all matters
submitted to a vote of our stockholders. The holders of Series B
Preferred Stock are not entitled to vote on any matter (except as
provided in Delaware law in connection with amendments to our

424B1 75th Page of 174 TOC 1st Previous Next ↓Bottom Just 75th
charter that, among other things, would alter or change the rights and
preferences of the class, in which case each share of Series B Preferred
Stock would be entitled to one vote). However, the Series B Preferred
Stock is convertible into common stock, and as a result, may dilute the
voting power of the common stock.

- Liquidation, Dissolution or Winding Up. The preferred stock is entitled
to certain liquidation preferences upon the occurrence of a liquidation,
dissolution or winding up of our company. If there are insufficient
assets or funds to permit this preferential amount, then our entire
assets and all of our funds legally available for distribution will be
distributed ratably among the preferred stockholders. The remaining
assets, if any, will be distributed to the common stockholders on a pro
rata basis.

- Preemptive Rights. Our Series A and Series B preferred stock do not have
any preemptive rights.

WARRANTS

As of December 31, 2002, Xerox owned a warrant to purchase up to a maximum
of 525,732 shares of our common stock at an exercise price of $0.61 per share.

REGISTRATION RIGHTS

Prior to the filing of this prospectus, certain parties are entitled to
have some of their shares of our stock registered under the Securities Act
pursuant to registration rights or share purchase agreements between us and each
of these parties. Specifically, Xerox has the right to register all of its
15,941,572 shares, consisting of common, preferred and warrant shares; and
Merrill Lynch, Pierce Fenner & Smith Incorporated ("Merrill Lynch"), the State
of Wisconsin Investment Board, and SF Capital Partners have the right to
register, respectively, 65,100; 3,500,000; and 1,000,000 shares of our common
stock.

On a separate registration statement, we are registering 9,000,000 shares
of common stock on behalf of certain of our stockholders. Of these shares,
4,500,000 shares are being registered on behalf of Xerox, 3,500,000 shares are
being registered on behalf of SWIB and 1,000,000 shares are being registered on
behalf of SF Capital. Each of these stockholders has agreed that it will not
offer, sell or otherwise dispose of any of our securities with respect to which
it has registration rights, including the shares covered by that registration
statement, for a period of 90 days after the date of this prospectus. Thomas
Weisel Partners is the only party that may, in its sole discretion, modify or
waive the 90-day period.

Xerox

Under a Registration Rights Agreement dated as of March 2, 1999 between us
and Xerox, if Xerox requests that at least 10% of its registrable securities be
registered, we may be required, on up to three occasions, to register Xerox's
common, preferred and warrant shares for public resale.

If we are eligible to file registration statements on Form S-3, Xerox may
require us to register their remaining shares for public resale on Form S-3 up
to two times per 12-month period. Depending on market conditions, however, we
may defer such registration for up to 60 days.

Furthermore, in the event we elect to register any of our shares of common
stock for purposes of effecting any public offering, Xerox is entitled to
include a portion of its shares of common stock in the registration, but we may
reduce the number of shares proposed to be registered in view of market
conditions.

All expenses in connection with any registration, other than underwriting
discounts and commissions, will be borne by us. Xerox's registration rights will
terminate when Xerox is entitled to sell all of its shares in any 90-day period
under Rule 144 of the Securities Act.

424B1 76th Page of 174 TOC 1st Previous Next ↓Bottom Just 76th
Merrill Lynch

Under a Registration Rights Agreement between us and Merrill Lynch, upon
written request, Merrill Lynch may demand to have its registrable securities
registered for public resale on a Form S-3. In certain cases, we may defer such
registration for up to 60 days. All registration expenses incurred in connection
with our obligations under the Registration Rights Agreement will be borne by
us. The registration rights of Merrill Lynch are subordinate in all respects to
the registration rights of Xerox described above.

Philips

Under a Plan of Distribution Agreement dated January 30, 2003 between us
and Philips, Philips has agreed that prior to January 30, 2004, it will not
transfer or otherwise dispose of any shares of common stock it receives upon
conversion of its $27.5 million convertible debenture. After this date, Philips
may provide us with notice of its desire to sell any of its shares, and we must
discuss with Philips in good faith a mutually agreeable plan of distribution for
the shares desired to be sold. This plan may include the registration of the
shares for sale to the public or a private placement. If we cannot mutually
agree on a plan of distribution, Philips may sell pursuant to Rule 144 or other
applicable exemption from registration a number of shares per fiscal quarter not
greater than 25% of the shares into which the convertible debenture was
initially convertible. In any event, after January 30, 2004, in the event we
elect to register any of our shares of common stock for purposes of effecting
any public offering, Philips is entitled to include a portion of its shares of
common stock in the registration, subject to reduction in certain circumstances.

ANTI-TAKEOVER PROVISIONS

Certain provisions of Delaware law, our Preferred Shares Rights Agreement,
and our certificate of incorporation and bylaws could make the following more
difficult: the acquisition of our company by means of a tender offer, or the
acquisition of control of our company by means of a proxy contest or otherwise.
These provisions, summarized below, are intended to discourage certain types of
coercive takeover practices and inadequate takeover bids, and are designed to
encourage persons seeking to acquire control of us to negotiate with our board
of directors. We believe that the benefits of increased protection against an
unfriendly or unsolicited proposal to acquire or restructure us outweigh the
disadvantages of discouraging such proposals. Among other things, negotiation of
such proposals could result in an improvement of their terms.

Delaware Anti-Takeover Law. We are subject to Section 203 of the Delaware
General Corporation Law, an anti-takeover law. In general, Section 203 prohibits
a publicly-held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years following the date
the person became an interested stockholder, unless the "business combination"
or the transaction in which the person became an interested stockholder is
approved by our board of directors in a prescribed manner. Generally, a
"business combination" includes a merger, asset or stock sale, or other
transaction resulting in a financial benefit to the interested stockholder.
Generally, an "interested stockholder" is a person who, together with affiliates
and associates, owns or, within three years prior to the determination of
interested stockholder status, did own, 15% or more of a corporation's voting
stock. The existence of this provision may have an anti-takeover effect with
respect to transactions not approved in advance by the board of directors,
including discouraging attempts that might result in a premium over the market
price for the shares of common stock held by stockholders.

Preferred Shares Rights Agreement. On October 23, 1996, our board of
directors adopted a resolution creating a series of preferred stock designated
as Series A Participating Preferred Stock and declaring a dividend of one
preferred share purchase right for each outstanding share of our common stock
with each right entitling the registered holder to purchase one one-thousandth
of a share of our Series A Participating Preferred Stock. The terms of the
preferred share purchase rights are contained in a Preferred Share Rights
Agreement. This arrangement is designed to protect and maximize the value of our
outstanding equity interests in the company in the event of an unsolicited
attempt by an acquiror to take

424B1 77th Page of 174 TOC 1st Previous Next ↓Bottom Just 77th
over our company in a manner or on terms not approved by our board. Takeover
attempts frequently include coercive tactics to deprive a corporation's board of
directors and its stockholders of any real opportunity to determine the
direction of the corporation.

The Preferred Shares Rights Agreement is aimed to deter such tactics. It
may have the effect of rendering more difficult or discouraging an acquisition
of our company deemed undesirable by our board, by, for example, causing
substantial dilution to a person or group that attempts to acquire us on terms
or in a manner not approved by our board. The preferred share purchase rights
described above are triggered within ten days after the accumulation of 20% or
more of our outstanding common stocks by a single acquiror or group.

Our Preferred Share Rights Agreement and accompanying preferred share
purchase rights do not in any way weaken the financial strength of our company
or interfere with its business plans. Rather, we believe that they represent a
sound and reasonable means of addressing the complex issues of corporate policy
created by the current takeover environment. Additionally, they should not
preclude any merger or business combination approved by our board.

Other Provisions in our Charter and Bylaws. Our charter and bylaws provide
other mechanisms that may help to delay, defer or prevent a change in control.
For example, our charter provides that stockholders may not take action by
written consent without a meeting, but must take any action at a duly called
annual or special meeting. This provision makes it more difficult for
stockholders to take action opposed by our board.

Our charter does not provide for cumulative voting in the election of
directors, which under Delaware law, precludes stockholders from cumulating
their votes in the election of directors, which consequently frustrates the
ability of minority stockholders to obtain representation on the board of
directors.

Under our charter, 24,900,000 shares of preferred stock remain
undesignated. The authorization of undesignated preferred stock makes it
possible for the board of directors, without stockholder approval, to issue
preferred stock with voting or other rights or preferences that could impede the
success of any attempt to obtain control of us (see Preferred Shares Rights
Agreement discussion above).

Lastly, our bylaws contain advance notice procedures which apply to
stockholder proposals and the nomination of candidates for election as directors
by stockholders rather than the board.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for our common stock is U.S. Stock
Transfer Corporation.

NASDAQ NATIONAL MARKET LISTING

Our common stock is quoted on the Nasdaq National Market under the symbol
"SSFT." On February 10, 2003, the last reported sale price of our common stock
was $4.15 per share.

424B1 78th Page of 174 TOC 1st Previous Next ↓Bottom Just 78th
SHARES ELIGIBLE FOR FUTURE SALE

Future sales of substantial amounts of common stock, including shares
issued upon exercise of outstanding options and warrants, in the public market
following this offering could adversely affect market prices prevailing from
time to time and could impair our ability to raise capital through sale of our
equity securities. Sales of substantial amounts of our common stock in the
public market after the restrictions lapse could adversely affect the prevailing
market price and our ability to raise equity capital in the future.

Upon completion of this offering, based upon shares outstanding as of
December 31, 2002, we will have 64,422,776 outstanding shares of common stock,
or 65,495,276 shares of common stock if the underwriters' over-allotment option
is exercised in full, and assuming no exercise of any outstanding options or
warrants. The 7,184,406 shares sold in this offering will be freely tradable
without restriction under the Securities Act, unless purchased by our
"affiliates," as that term is defined in Rule 144 under the Securities Act, or
stockholders subject to the lock-up agreements described in the "Underwriting"
section of this prospectus. We have filed a separate registration statement
covering the registration on behalf of certain of our stockholders of 9,000,000
shares of our common stock. Each of these stockholders has agreed that it will
not offer, sell or otherwise dispose of any of our securities with respect to
which it has registration rights, including the shares covered by that
registration statement, for a period of 90 days after the date of this
prospectus. Thomas Weisel Partners is the only party that may, in its sole
discretion, modify or waive this 90-day period. In addition, the following table
shows when certain of our restricted shares may be sold in the public market
pursuant to Rule 144:

[Enlarge/Download Table]

DATE NUMBER OF SHARES ELIGIBLE FOR SALE COMMENT
---------------- ---------------------------------- --------------------------------------------

Current 4,791,905 shares saleable pursuant to Rule 144,
subject to volume limitations
90 days after
the date of this
prospectus 20,441,572 shares saleable pursuant to Rule 144,
subject to volume limitations
90 days after
the date of this
prospectus 65,100 shares saleable pursuant to Rule 144,
without regard to volume limitations

Generally, under Rule 144 of the Securities Act, a person who has
beneficially owned restricted shares for at least one year, including persons
who are affiliates, would be entitled to sell within any three-month period a
number of shares that does not exceed the greater of:

- 1% of our outstanding shares of common stock, which amount was 634,228
shares as of December 31, 2002; or

- the reported average weekly trading volume of our common stock during the
four calendar weeks preceding a sale by such person.

Shares under Rule 144 are also subject to manner-of-sale provisions, notice
requirements and the availability of current public information.

424B1 79th Page of 174 TOC 1st Previous Next ↓Bottom Just 79th
UNDERWRITING

GENERAL

Subject to the terms and conditions set forth in an underwriting agreement,
each of the underwriters named below has severally agreed to purchase from us
and the selling stockholders the aggregate number of shares of common stock set
forth opposite its name below:

[Download Table]

UNDERWRITERS NUMBER OF SHARES
------------ ----------------

Thomas Weisel Partners LLC.................................. 4,669,864
Adams, Harkness & Hill, Inc................................. 1,796,102
Investec Inc................................................ 718,440
-----------
Total............................................. 7,184,406
===========

Of the 7,184,406 shares to be purchased by the underwriters, 1,000,000
shares will be purchased from us and 6,184,406 will be purchased from the
selling stockholders.

The underwriting agreement provides that the obligations of the several
underwriters are subject to various conditions, including approval of legal
matters by counsel. The nature of the underwriters' obligations commits them to
purchase and pay for all of the shares of common stock listed above if any are
purchased.

The underwriting agreement provides that we and the selling stockholders
will indemnify the underwriters against certain liabilities specified in the
underwriting agreement, or will contribute to payments that the underwriters may
be required to make relating to these liabilities.

The underwriters expect to deliver the shares of common stock to purchasers
on or about February 14, 2003.

OVER-ALLOTMENT OPTION

We have granted a 30-day over-allotment option to the underwriters to
purchase up to a total of 1,072,500 additional shares of our common stock from
us at the public offering price, less the underwriting discounts payable by us,
as set forth on the cover page of this prospectus. If the underwriters exercise
this option in whole or in part, then each of the underwriters will be
separately committed, subject to conditions described in the underwriting
agreement, to purchase the additional shares of our common stock in proportion
to their respective commitments set forth in the table above.

COMMISSIONS AND DISCOUNTS

The underwriters propose to offer the shares of common stock directly to
the public at the public offering price set forth on the cover page of this
prospectus, and at this price less a concession not in excess of $0.1425 per
share of common stock to other dealers specified in a master agreement among
underwriters who are members of the National Association of Securities Dealers,
Inc. The underwriters may allow, and the other dealers specified may re-allow,
concessions, not in excess of $0.10 per share of common stock to these other
dealers. After this offering, the offering price, concessions and other selling
terms may be changed by the underwriters. Our common stock is offered subject to
receipt and acceptance by the underwriters and to the other conditions,
including the right to reject orders in whole or in part.

As consideration for services, including advice with respect to timing,
size and other aspects of this offering, rendered in the distribution, Evercore
Partners L.P. will be paid a fee of $287,500 of which $100,000 will be paid by
the underwriters upon completion of the offering and $187,500 will be paid
directly by us.

424B1 80th Page of 174 TOC 1st Previous Next ↓Bottom Just 80th
The following table summarizes the compensation to be paid to the
underwriters by us and the proceeds, before expenses, payable to us and the
selling stockholder:

[Enlarge/Download Table]

TOTAL
-------------------------------
WITHOUT OVER- WITH OVER-
PER SHARE ALLOTMENT ALLOTMENT
--------- -------------- --------------

Public offering price....................... $3.8000 $27,300,742.80 $31,376,242.80
Underwriting discount....................... $0.2375 $ 1,706,296.42 $ 1,961,015.17
Proceeds, before expenses, to us............ $3.5625 $ 3,562,500.00 $ 7,383,281.25
Proceeds, before expenses, to selling
stockholders.............................. $3.5625 $22,031,946.38 $22,031,946.38

INDEMNIFICATION OF UNDERWRITERS

We and the selling stockholders will indemnify the underwriters against
some civil liabilities, including liabilities under the Securities Act of 1933,
as amended, and liabilities arising from breaches of our representations and
warranties contained in the underwriting agreement. If we or the selling
stockholders are unable to provide this indemnification, we and the selling
stockholders will contribute to payments the underwriters may be required to
make in respect of those liabilities.

NO SALES OF SIMILAR SECURITIES

The underwriters will require our directors and executive officers to agree
not to offer, sell, agree to sell, directly of indirectly, or otherwise dispose
of any shares of common stock or any securities convertible into or exchangeable
for shares of common stock without the prior written consent of Thomas Weisel
Partners for a period of 180 days after the date of the initial filing of the
registration statement, of which this prospectus is a part. Thomas Weisel
Partners is the only party that may, in its sole discretion, modify or waive
this 180-day period. Thomas Weisel Partners has no current intention to release
any of these parties from its obligations under the applicable lock-up agreement
or to shorten any lock-up period. Thomas Weisel Partners will only release a
party from its obligations under a lock-up agreement or shorten any lock-up
period if Thomas Weisel Partners determines, in its sole discretion, that such
release or shortening will be in the best interests of ScanSoft and our
stockholders. At this time Thomas Weisel Partners does not envisage a situation
in which it would provide such a release or shortening.

We have agreed that for a period of 90 days after the date of this
prospectus, we will not, without the prior written consent of Thomas Weisel
Partners, offer, sell or otherwise dispose of any shares of common stock, or any
securities exercisable for or convertible into shares of common stock, except
for the shares of common stock offered in this offering, the shares of common
stock issuable upon exercise of outstanding options and warrants on the date of
this prospectus and the shares of our common stock that are issued under our
equity compensation plans. Thomas Weisel Partners is the only party that may, in
its sole discretion, modify or waive this 90-day period. Thomas Weisel Partners
has no current intention to release us from our obligations under the lock-up
agreement or to shorten the lock-up period. Thomas Weisel Partners will only
release us from our obligations under the lock-up agreement or shorten the
lock-up period if Thomas Weisel Partners determines, in its sole discretion,
that such release or shortening will be in the best interests of ScanSoft and
our stockholders. At this time Thomas Weisel Partners does not envisage a
situation in which it would provide such a release or shortening.

The previous paragraph notwithstanding, during the 90-day lock-up period we
may issue shares of common stock, or securities exchangeable for or convertible
into shares of common stock, solely as consideration for the acquisition
(whether through merger, share purchase, share exchange or otherwise) of a
company, a business, a division or assets. If the capital stock of an acquired
company or of the company selling the business, division or assets is publicly
traded, we may issue these securities without restriction. If the capital stock
of an acquired company or of the company selling the business, division or
assets is not publicly traded, the securities so issued by us shall not be
freely tradable, and each recipient of the securities issued by us shall agree
not to sell, agree to sell, directly or indirectly, or otherwise dispose

424B1 81st Page of 174 TOC 1st Previous Next ↓Bottom Just 81st
or those securities without the consent of Thomas Weisel Partners in each case
until the conclusion of the 90-day lock-up period.

In connection with our filing of a separate registration statement covering
the registration on behalf of certain stockholders of 9,000,000 shares of our
common stock, each of those stockholders has agreed that it will not offer, sell
or otherwise dispose of any of our securities with respect to which it has
registration rights, including the shares covered by that registration
statement, for a period of 90 days after the date of this prospectus. Thomas
Weisel Partners is the only party that may, in its sole discretion, modify or
waive this 90-day period. Thomas Weisel Partners has no current intention to
release any of these parties from its obligations under the applicable lock-up
agreement or to shorten any lock-up period. Thomas Weisel Partners will only
release a party from its obligations under a lock-up agreement or shorten any
lock-up period if Thomas Weisel Partners determines, in its sole discretion,
that such release or shortening will be in the best interests of ScanSoft and
our stockholders. At this time Thomas Weisel Partners does not envisage a
situation in which it would provide such a release or shortening.

NASDAQ NATIONAL MARKET LISTING

Our common stock is quoted on the Nasdaq National Market under the symbol
"SSFT."

STABILIZING TRANSACTIONS AND PENALTY BIDS

Until the distribution of the shares of common stock is completed, rules of
the Securities and Exchange Commission may limit the ability of the underwriters
to bid for and purchase our common stock. As an exception to these rules, in
order to facilitate the offering, persons participating in the offering are
permitted to engage in certain transactions that stabilize the price of our
common stock during and after the offering. These transactions may include bids
or purchases for the purpose of pegging, fixing or maintaining the price of our
common stock.

If the underwriters sell a larger number of shares of common stock than are
set forth on the cover page of this prospectus, the underwriters may cover the
sale of those additional shares by purchasing common stock in the open market.
The underwriters may also elect to cover the sale of those additional shares by
exercising all or part of the over-allotment option described above. In
determining how to cover the sale of the additional shares, the underwriters
will consider, among other things, the price of shares available in the open
market as compared to the price at which they may purchase shares through the
over-allotment option.

If the underwriters purchase shares in the open market in a stabilizing
transaction or syndicate covering transaction, they may reclaim a selling
concession from the underwriters and selling group members who sold those shares
as part of this offering. Stabilization and syndicate covering transactions may
cause the price of the shares to be higher than it would be in the absence of
these transactions. The imposition of a penalty bid might also have an effect on
the price of the shares if it discourages presales of the shares.

The transactions above may occur on the Nasdaq National Market or
otherwise. Neither we nor the underwriters make any representation or prediction
as to the effect that the transactions described above may have on the price of
the shares. If these transactions are commenced, they may be discontinued
without notice at any time.

424B1 82nd Page of 174 TOC 1st Previous Next ↓Bottom Just 82nd
LEGAL MATTERS

The validity of the shares offered hereby will be passed upon by Wilson
Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California.
Katharine A. Martin, one of our directors, is a member of Wilson Sonsini
Goodrich & Rosati. See Certain Relationships and Securities Transactions above.
Sidley Austin Brown & Wood LLP, New York, New York, will pass upon certain legal
matters in connection with this offering for the underwriters.

EXPERTS

The financial statements of ScanSoft, Inc. as of December 31, 2001 and 2000
and for each of the three years in the period ended December 31, 2001 included
in this Prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.

The combined balance sheets of Philips Speech Processing Telephony and
Voice Control (a division of Royal Philips Electronics N.V.) as of December 31,
2001 and September 29, 2002, and the related combined statements of operations
and comprehensive loss, changes in the net investment of the Philips Group, and
cash flows for the year ended December 31, 2001 and the nine-month period ended
September 29, 2002, appearing elsewhere herein have been included in reliance
upon the report of KPMG Accountants N.V., Eindhoven, The Netherlands,
independent accountants, upon the authority of said firm as experts in auditing
and accounting.

The financial statements of the Speech and Language Technologies operations
of Lernout & Hauspie Speech Products N.V. as of September 30, 2001 and for the
nine months ended September 30, 2001 included in this Prospectus have been so
included in reliance on the report of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and current reports, proxy and information
statements and other information with the SEC. You can inspect and copy these
reports, proxy and information statements and other information concerning
ScanSoft at the SEC's public reference facilities at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549. Information on the operation of the Public
Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC also
maintains a site on the Web at www.sec.gov that contains reports, proxy and
information statements and other information about us.

This prospectus is part of a Registration Statement on Form S-1 that we
filed with the SEC to register shares of our common stock. This prospectus does
not contain all of the information contained in the Registration Statement. The
Registration Statement together with its exhibits can be inspected and copied at
the public reference facilities of the SEC referred to above.

424B1 83rd Page of 174 TOC 1st Previous Next ↓Bottom Just 83rd
SCANSOFT, INC.

INDEX TO FINANCIAL STATEMENTS

[Download Table]

PAGE
----

CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001
AND 2000 AND FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND
1999
Report of Independent Accountants......................... F-2
Consolidated Balance Sheets............................... F-3
Consolidated Statements of Operations..................... F-4
Consolidated Statements of Stockholders' Equity........... F-5
Consolidated Statements of Cash Flows..................... F-6
Notes to Consolidated Financial Statements................ F-7
FINANCIAL STATEMENT SCHEDULE
Report of Independent Accountants on Financial Statement
Schedule............................................... F-32
Schedule II -- Valuation and Qualifying Accounts and
Reserves............................................... F-33
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER
30, 2002 AND DECEMBER 31, 2001 AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2002 AND 2001
Consolidated Balance Sheets (Unaudited)................... F-35
Consolidated Statements of Operations (Unaudited)......... F-36
Consolidated Statements of Cash Flows (Unaudited)......... F-37
Notes to Unaudited Consolidated Financial Statements...... F-38
COMBINED FINANCIAL STATEMENTS OF THE PHILIPS SPEECH
PROCESSING TELEPHONY AND VOICE CONTROL DIVISION OF ROYAL
PHILIPS ELECTRONICS N.V.
Independent Auditors' Report.............................. F-49
Combined Balance Sheets................................... F-50
Combined Statements of Operations and Comprehensive
Loss................................................... F-51
Changes in the Net Investment of the Philips Group........ F-52
Combined Statements of Cash Flows......................... F-53
Notes to the Combined Financial Statements................ F-54
FINANCIAL STATEMENTS OF THE SPEECH AND LANGUAGE TECHNOLOGIES
OPERATIONS OF LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.
Report of Independent Accountants......................... F-71
Statement of Assets and Liabilities as of September 30,
2001................................................... F-72
Statement of Revenue and Direct Operating Expenses for the
Nine Months Ended September 30, 2001................... F-73
Notes to Financial Statements............................. F-74
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
Introduction to the Unaudited Pro Forma Combined Financial
Statements............................................. F-83
Unaudited Pro Forma Combined Balance Sheet as of September
30, 2002............................................... F-84
Unaudited Pro Forma Combined Statement of Operations for
the Year Ended December 31, 2001....................... F-85
Unaudited Pro Forma Combined Statement of Operations for
the Nine Months Ended September 30, 2002............... F-86
Notes to Unaudited Pro Forma Combined Financial
Statements............................................. F-87

F-1

424B1 84th Page of 174 TOC 1st Previous Next ↓Bottom Just 84th
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of ScanSoft, Inc:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
ScanSoft, Inc. and its subsidiaries at December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts
February 11, 2002, except as to Note 15
for which the date is March 5, 2002

F-2

424B1 85th Page of 174 TOC 1st Previous Next ↓Bottom Just 85th
SCANSOFT, INC.

CONSOLIDATED BALANCE SHEETS

[Enlarge/Download Table]

DECEMBER 31,
---------------------------
2001 2000
------------ ------------
(IN THOUSANDS,
EXCEPT SHARE AND PER SHARE
AMOUNTS)

ASSETS
Current assets:
Cash and cash equivalents................................. $ 14,324 $ 2,571
Short-term investments.................................... -- 62
Accounts receivable, less allowances of $6,273 and $7,375,
respectively........................................... 12,464 6,727
Receivables from related party (Note 13).................. 1,802 1,587
Inventory................................................. 507 806
Prepaid expenses and other current assets................. 1,614 1,610
--------- ---------
Total current assets................................... 30,711 13,363
Goodwill and other intangible assets, net................. 108,532 92,051
Property and equipment, net............................... 2,150 2,954
Other assets.............................................. 677 1,112
--------- ---------
Total assets........................................... $ 142,070 $ 109,480
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 5,320 $ 7,945
Accrued expenses.......................................... 14,471 7,418
Deferred revenue.......................................... 1,375 1,084
Short-term bank borrowings................................ -- 3,400
Note payable.............................................. 227 --
--------- ---------
Total current liabilities.............................. 21,393 19,847
Deferred revenue............................................ 2,534 2,172
Long-term note payable, net of current portion.............. 3,273 --
Other liabilities........................................... 336 --
--------- ---------
Total liabilities...................................... 27,536 22,019
--------- ---------
Commitments and contingencies (Notes 5, 7 and 11)
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; 62,754,211 and 46,072,748 shares issued and
62,098,211 and 46,072,748 shares outstanding,
respectively........................................... 63 46
Additional paid-in capital................................ 264,893 219,259
Treasury stock at cost (656,000 and no shares,
respectively).......................................... (1,031) --
Deferred compensation..................................... (276) --
Accumulated other comprehensive loss...................... (487) (93)
Accumulated deficit....................................... (153,259) (136,382)
--------- ---------
Total stockholders' equity............................. 114,534 87,461
--------- ---------
Total liabilities and stockholders' equity............. $ 142,070 $ 109,480
========= =========

The accompanying notes are an integral part of these consolidated financial
statements.
F-3

424B1 86th Page of 174 TOC 1st Previous Next ↓Bottom Just 86th
SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)

Revenue, third parties...................................... $ 56,647 $ 43,071 $26,933
Revenue, related party...................................... 7,208 5,984 4,696
-------- -------- -------
Total revenue............................................. 63,855 49,055 31,629
-------- -------- -------
Costs and expenses:
Cost of revenue........................................... 12,849 12,692 7,602
Cost of revenue from amortization of intangible assets.... 14,192 11,569 1,405
Research and development.................................. 13,968 14,967 6,920
Selling, general and administrative....................... 26,449 28,205 14,509
Amortization of goodwill and other intangible assets...... 13,328 11,017 516
Restructuring and other charges, net...................... -- 4,811 346
Acquired in-process research and development.............. -- 18,291 3,944
-------- -------- -------
Total costs and expenses............................... 80,786 101,552 35,242
-------- -------- -------
Loss from operations........................................ (16,931) (52,497) (3,613)
Other income (expense):
Interest income........................................... 209 112 181
Interest expense.......................................... (166) (620) (56)
Other (expense) income, net............................... (306) 226 8
Gain on sale of hardware business......................... -- -- 882
-------- -------- -------
Loss before income taxes.................................... (17,194) (52,779) (2,598)
Provision for (benefit from) income taxes................... (317) 472 150
-------- -------- -------
Net loss.................................................... $(16,877) $(53,251) $(2,748)
======== ======== =======
Net loss per share: basic and diluted....................... $ (0.34) $ (1.26) $ (0.11)
======== ======== =======
Weighted average common shares outstanding: basic and
diluted................................................... 49,693 42,107 25,630
======== ======== =======

The accompanying notes are an integral part of these consolidated financial
statements.
F-4

424B1 87th Page of 174 TOC 1st Previous Next ↓Bottom Just 87th
SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

[Enlarge/Download Table]

PREFERRED STOCK COMMON STOCK TREASURY STOCK
------------------ ------------------- ADDITIONAL ----------------- DEFERRED
SHARES AMOUNT SHARES AMOUNT PAID-IN CAPITAL SHARES DOLLARS COMPENSATION
--------- ------ ---------- ------ --------------- ------- ------- ------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

Balance at December 31,
1998....................... 19,852,952 $ 20 $ 87,995 $ (50)
Issuance of common stock
under employee stock
compensation plans......... 412,823 276
Compensation expense related
to stock options........... 50
Issuance of preferred stock,
common stock and common
stock options in connection
with ScanSoft acquisition.. 3,562,238 $4,631 6,755,992 7 12,810
Common stock repurchased and
retired.................... (331,740) (684)
Net loss.....................
--------- ------ ---------- ---- -------- ------- ------- -----
Balance at December 31,
1999....................... 3,562,238 4,631 26,690,027 27 100,397 -- -- --
Issuance of common stock
under employee stock
compensation plans......... 354,203 815
Issuance of common stock and
common stock options in
connection with Caere
merger..................... 19,028,518 19 118,047
Comprehensive loss:
Net loss.....................
Foreign currency translation
adjustment.................
Comprehensive loss.........
--------- ------ ---------- ---- -------- ------- ------- -----
Balance at December 31,
2000....................... 3,562,238 4,631 46,072,748 46 219,259 -- -- --
Issuance of common stock
under employee stock
compensation plans......... 623,534 1 1,130
Issuance of common stock in
connection with L&H
acquisition................ 7,400,000 8 27,792
Issuance of common stock in
connection with equity
investment................. 8,261,905 8 15,721
Issuance of common stock in
connection with settlement
of Caere acquisition
liability.................. 262,200 700
Issuance of restricted
stock...................... 133,824 291 (291)
Compensation expense
associated with restricted
stock...................... 15
Repurchase of common stock
at.........................
cost....................... 656,000 $(1,031)
Comprehensive loss:
Net loss.....................
Foreign currency translation
adjustment.................
Comprehensive loss.........
--------- ------ ---------- ---- -------- ------- ------- -----
Balance at December 31,
2001....................... 3,562,238 $4,631 62,754,211 $ 63 $264,893 656,000 $(1,031) $(276)
========= ====== ========== ==== ======== ======= ======= =====

ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
LOSS DEFICIT EQUITY LOSS
------------- ----------- ------------- -------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

Balance at December 31,
1998....................... $ (80,383) $ 7,582
Issuance of common stock
under employee stock
compensation plans......... 276
Compensation expense related
to stock options........... 50
Issuance of preferred stock,
common stock and common
stock options in connection
with ScanSoft acquisition.. 17,448
Common stock repurchased and
retired.................... (684)
Net loss..................... (2,748) (2,748) $ (2,748)
--------- -------- ========
Balance at December 31,
1999....................... (83,131) 21,924
Issuance of common stock
under employee stock
compensation plans......... 815
Issuance of common stock and
common stock options in
connection with Caere
merger..................... 118,066
Comprehensive loss:
Net loss..................... (53,251) (53,251) (53,251)
Foreign currency translation
adjustment................. $ (93) (93) (93)
--------
Comprehensive loss......... $(53,344)
----- --------- -------- ========
Balance at December 31,
2000....................... (93) (136,382) 87,461
Issuance of common stock
under employee stock
compensation plans......... 1,131
Issuance of common stock in
connection with L&H
acquisition................ 27,800
Issuance of common stock in
connection with equity
investment................. 15,729
Issuance of common stock in
connection with settlement
of Caere acquisition
liability.................. 700
Issuance of restricted
stock...................... --
Compensation expense
associated with restricted
stock...................... 15
Repurchase of common stock
at.........................
cost....................... (1,031)
Comprehensive loss:
Net loss..................... (16,877) (16,877) (16,877)
Foreign currency translation
adjustment................. (394) (394) (394)
--------
Comprehensive loss......... $(17,271)
----- --------- -------- ========
Balance at December 31,
2001....................... $(487) $(153,259) $114,534
===== ========= ========

The accompanying notes are an integral part of these consolidated financial
statements.

F-5

424B1 88th Page of 174 TOC 1st Previous Next ↓Bottom Just 88th
SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
(IN THOUSANDS)

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................................... $(16,877) $(53,251) $(2,748)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation........................................... 1,762 2,091 240
Amortization of goodwill and other intangible assets... 27,520 22,586 1,921
Accounts receivable allowances......................... (1,102) (2,904) 2,100
Write-off of acquired in-process research and
development.......................................... -- 18,291 3,944
Provision for impairment of intangible assets.......... -- 3,490 --
Non-cash portion of restructuring charge............... -- 272 --
Gain on settlement of acquisition liability............ (1,050) -- --
Net gain on sale of hardware business.................. -- -- (882)
Other.................................................. (68) -- 52
Changes in operating assets and liabilities, net of
effects from acquisitions:
Accounts receivable.................................. (252) 3,740 (7,291)
Inventory............................................ 418 257 (248)
Prepaid expenses and other current assets............ 18 278 (540)
Other assets......................................... 435 (441) (122)
Accounts payable..................................... (542) (700) 1,463
Accrued expenses..................................... (543) (1,547) (508)
Deferred revenue..................................... 653 2,292 121
-------- -------- -------
Net cash provided by (used in) operating
activities...................................... 10,372 (5,546) (2,498)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment........... (943) (1,048) (840)
Proceeds from sale of property and equipment.............. 344 -- --
Cash paid for acquisition, including transaction costs.... (10,118) -- --
Cash of businesses acquired, net of cash paid............. -- 1,419 211
Net change in restricted cash............................. 62 -- 262
Proceeds from sale of hardware business................... -- -- 6,788
Net sales (purchase) of short-term and other
investments............................................ -- -- (10)
-------- -------- -------
Net cash provided by (used in) investing
activities...................................... (10,655) 371 6,411
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Short-term bank borrowings, net........................... (3,400) 3,400 (6,000)
Payment of note payable................................... -- (1,600) --
Repurchase of common stock................................ (1,031) -- (684)
Proceeds from issuance of common stock, net of issuance
costs.................................................. 16,862 815 274
-------- -------- -------
Net cash provided by (used in) financing
activities...................................... 12,431 2,615 (6,410)
-------- -------- -------
Effects of exchange rate changes on cash and cash
equivalents............................................... (395) (31) --
-------- -------- -------
Net increase (decrease) in cash and cash equivalents........ 11,753 (2,591) (2,497)
Cash and cash equivalents at beginning of year.............. 2,571 5,162 7,659
-------- -------- -------
Cash and cash equivalents at end of year.................... $ 14,324 $ 2,571 $ 5,162
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest.................... $ 135 $ 635 $ --

The accompanying notes are an integral part of these consolidated financial
statements.
F-6

424B1 89th Page of 174 TOC 1st Previous Next ↓Bottom Just 89th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND PRESENTATION

ScanSoft, Inc. was incorporated as Visioneer, Inc. in March 1992 and
through December 1998, developed and sold scanner hardware and software
products. On January 6, 1999, Visioneer sold the hardware business and the
Visioneer brand name to Primax Electronics, Ltd., and on March 2, 1999,
Visioneer acquired ScanSoft, in a cash election merger, from Xerox Corporation.
The corporate entity "Visioneer" survived the merger, but changed its name to
"ScanSoft, Inc." In addition, Visioneer changed the ticker symbol for its common
stock that trades on the Nasdaq, to "SSFT." On March 13, 2000, the Company
merged with Caere Corporation ("Caere"), a California-based digital imaging
software company. The acquisitions of ScanSoft and Caere were accounted for
under the purchase method of accounting and, accordingly, the results of
operations of ScanSoft and Caere have been included in the Company's financial
statements as of the acquisition dates.

When we refer to "we" or "ScanSoft" or "the Company," we mean the current
Delaware corporation ScanSoft, Inc., including all of its consolidated
subsidiaries.

ACCOUNTING FOR ACQUISITION

On December 12, 2001, the Company acquired certain assets of Lernout &
Hauspie Speech Products N.V. and certain of its affiliates. On December 27,
2001, the Company filed a Form 8-K reporting the transaction as an acquisition
of assets. The Company had ongoing discussions with the SEC regarding historical
financial statement requirements related to the acquisition. Following these
discussions, the Company concluded that, for purposes of Rule 3-05 of Regulation
S-X, the L&H transaction was an acquisition of a business and not an acquisition
of assets. In connection with these discussions, the Company also concluded that
the transaction should be reported as an acquisition of a business for
accounting purposes rather than an acquisition of assets, as previously
reported. On August 14, 2002, the Company filed a Form 10-Q/A to restate the
financial statements as of and for the quarter ended March 31, 2002 to reflect
the impact of the change in the accounting for the acquisition. The change in
the accounting for the transaction was determined to have an immaterial impact
on the financial position, results of operations or cash flows of the Company
for the year ended December 31, 2001.

The change in accounting for the transaction resulted in a reallocation of
the purchase price from amortizable intangible and tangible assets to goodwill.
The following summarizes the impact of the reallocation of the purchase price
(in 000's):

[Download Table]

DECEMBER 31, 2001
---------------------------
AS PREVIOUSLY
REPORTED AS REVISED
------------- -----------

Balance Sheet:
Goodwill, net...................................... $ 42,169 $ 65,231
Other intangible assets, net....................... 66,107 43,301
Property and equipment, net........................ 2,406 2,150
-------- --------
Total goodwill, other intangible assets and property
and equipment, net................................. $110,682 $110,682

ACQUISITION OF LERNOUT & HAUSPIE (L&H) SPEECH PRODUCTS N.V. ASSETS

F-7

424B1 90th Page of 174 TOC 1st Previous Next ↓Bottom Just 90th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

District of Delaware and the Belgium Court of Ieper. We purchased these assets
in a closed auction proceeding approved by both the United States and Belgium
courts on December 11, 2001. The transaction was completed on December 12, 2001.

Pursuant to the Purchase Agreement, the Company acquired patents,
trademarks, tradenames, product and customer contracts associated with certain
of the speech and language technology assets of L&H. In addition, the Company
also obtained rights to accounts receivable related to the customer contracts
acquired and fixed assets. The Company also hired 223 employees from L&H. The
Company paid $41.3 million in total consideration to the creditors as follows:
$10.0 million in cash, 7.4 million shares of the Company's common stock valued
at $27.8 million (based on the average of the closing share price of our stock 3
days before and after the proposed acquisition was announced) and a 9%
promissory note in the principal amount of $3.5 million, to be repaid in
installments of $0.1 million of principal and interest quarterly commencing on
March 15, 2002, for a total of eleven (11) payments. All remaining principal and
interest shall become due on December 15, 2004.

With the acquisition of certain of L&H's assets in December 2001, ScanSoft
added speech and language solutions to its portfolio of productivity-enhancing
applications and technologies. The group of assets acquired includes the
RealSpeak text-to-speech technology, Dragon speech recognition software and
other speech and voice-related technologies aimed at the rapidly growing
telecommunications, automotive and mobile device markets. ScanSoft believes that
its speech-based technology and intellectual property is widely considered the
finest in the industry.

The Company generated $10.4 million of cash from operations for 2001 and
had a cash balance of $14.3 million at December 31, 2001. The Company's cash
balance reflects lower operating expenses as a result of restructuring actions
and other cost reduction initiatives, taken in fiscal 2000, higher revenues
compared to fiscal 2000 and equity financings net of cash paid for the L&H
acquisition. The Company expects that operating expenses will increase in 2002
as a result of the L&H acquisition. While the Company believes its revenues will
also increase and therefore its cash flows from operations, cash generated from
operations could be negatively impacted if the Company's products are not
accepted in the markets in which it does business, by seasonality of customer
buying patterns or by a continued or worsened economic downturn in the United
States or international markets where its products are sold. There can be no
assurance that the Company will be able to continue to generate cash from
operations or secure additional equity financing if required. The Company has
sustained recurring losses and has an accumulated deficit at December 31, 2001.
The Company believes that operating expense levels in combination with expected
future revenues will continue to generate positive cash flows from operations.
The Company also believes that, should it experience any of the aforementioned
factors, it has the ability to reduce operating expenses to levels commensurate
with revenues to maintain positive cash flows from operations. The Company
believes that cash flows from future operations in addition to cash on hand will
be sufficient to meet its working capital, investing, financing and contractual
obligations as they become due for the foreseeable future including stock
repurchase programs and potential business or asset acquisitions.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATIONS

F-8

424B1 91st Page of 174 TOC 1st Previous Next ↓Bottom Just 91st
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

intangible assets including goodwill and the valuation allowances on deferred
tax assets. Actual results could differ from those estimates.

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Intercompany transactions and balances have
been eliminated.

FOREIGN CURRENCY TRANSLATION

The functional currency of the Company's foreign subsidiaries is the local
currency. Assets and liabilities of foreign subsidiaries that are denominated in
foreign currencies are translated into United States dollars at exchange rates
in effect at the balance sheet date. Revenue and expense items are translated
using the average exchange rates for the period. Net unrealized gains and losses
resulting from foreign currency translation are included in other comprehensive
loss, which is a separate component of stockholders' equity. Foreign currency
transaction gains and losses are included in results of operations. The Company
reported foreign currency transaction gains and (losses) of $0.2 million, $(0.1)
million and zero for the years ended 2001, 2000 and 1999, respectively.

REVENUE RECOGNITION

The Company derives revenues from the sale of its software products to
end-users through distribution partners and value added resellers (VARs),
royalties received from OEM partners, license fees from sales of its products to
end-users and from services, primarily maintenance associated with software
license transactions.

The Company applies the provisions of Statement of Position 97-2 Software
Revenue Recognition, as amended by Statement of Position 98-9 Modification of
SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, to
all transactions involving the sale of software products. In addition, the
Company applies the provisions of Staff Accounting Bulletin 101, Revenue
Recognition in Financial Statements. Accordingly, provided that the fee is fixed
or determinable and collection of the receivable is reasonably assured, the
Company generally recognizes revenue from sales of its software products upon
receipt of evidence of the arrangement and upon product shipment or deployment,
except for shipments to a distributor or reseller.

Under the terms of our agreements with distributors and authorized
resellers (including VARs), title and risk-of-loss pass to the customer upon
shipment, at which time the transaction is invoiced and payment is due.
Agreements provide distributors and resellers rights of return. As a result, the
Company recognizes revenue from sales to distributors and resellers only upon
sale of the products by the distributor or reseller to retailers or end-users.
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 inventory subject to return.

In addition, the Company records reserves for estimated sales returns by
retailers and end-users to it directly or through the Company's distributors or
resellers based 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. Such returns from retailers and end-users have not been
significant. Also, from time to time, the Company offers its customers rebates
or offers price protection incentive programs to retailers for the sale of the
Company's products. The Company estimates the impact on revenue of rebate or
price protection programs based upon its historical experiences with similar
programs for like products. The estimated reserve for such rebates or programs
is recorded as a reduction of revenue in the period when the rebate or price
protection program is available to the end-user or retailer.

The Company also receives royalties from agreements with original equipment
manufacturers (OEMs). Under the terms of its OEM licensing agreements, the
Company ships a master disk to the
F-9

424B1 92nd Page of 174 TOC 1st Previous Next ↓Bottom Just 92nd
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

OEM and permits the OEM to make multiple copies. Royalty payments are due to the
Company upon the OEM's deployment of copies of licensed software. Accordingly,
revenue from royalty fees is recognized when copies are deployed and payment is
due. The Company recognizes royalty revenue from OEMs for which the Company has
significant historical experience based on estimates of deployments in the
current period. The Company bases its estimates on timely, informal
communication with the OEM and the OEM's past royalty reporting and payment
history, the seasonality of its business, the number of copies deployed in
previous periods, and the overall economic environment in which the OEM is
operating. Differences between the Company's estimates and the actual copies
deployed in the period are recorded as an adjustment to revenue in the period
that they become known, generally one quarter later. The Company has not
experienced significant differences between its estimated and actual deployments
for any period presented.

The Company applies the residual method to account for revenues when an
order contains one or more elements to be delivered in the future (for example,
maintenance and support services or training) and when evidence of the fair
value of all undelivered elements exists. Under the residual method, the fair
value of the undelivered elements is initially deferred and the remaining
portion of the arrangement fee is recognized as revenues related to the
delivered elements. If evidence of the fair value of one or more of the
undelivered elements does not exist, all revenues are deferred and recognized
only when delivery of those elements occurs or when fair value can be
established. Vendor-specific objective evidence (VSOE) of the fair value of each
undelivered element is based on the prices charged by the Company to its
customers when these elements are sold separately or, in the case of some
maintenance services, based on the contractual maintenance renewal rates. VSOE
of the fair value of training service is based on the fee charged per day or per
student, depending on the type of training provided.

The Company recognizes revenue from the sale of maintenance and support to
end-users ratably over the contract period, usually one year. Payments received
in advance for maintenance and support revenue are initially recorded as
deferred revenue. Revenue from training service is recognized as it is provided.

The Company's products do not require installation or implementation by the
Company and do not require significant production, modification or customization
of the software. However, the Company occasionally enters into software license
agreements with customers that require significant modification of the software.
Revenue is recognized under these arrangements in accordance with Statement of
Position 81-1 (SOP 81-1), Accounting for Performance of Construction-Type and
Certain Performance-Type Contracts. Under the percentage-of-completion method,
the Company determines progress toward completion based on costs incurred to
date as compared with total estimated costs at the contract completion date.
Anticipated losses, if any, are recognized in the period in which determined.

CASH EQUIVALENTS

Cash equivalents are short-term, highly liquid instruments with original
maturities of 90 days or less at the date of acquisition. The Company invests
primarily in commercial paper.

INVENTORY

Inventory is stated at the lower of cost (determined on a first-in,
first-out basis) or market value. Costs incurred related to shipping and
handling of our inventory and products are recorded as a cost of revenue.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the term of the related lease or the useful
life, if shorter. The cost and related accumulated depreciation of sold or
retired assets

F-10

424B1 93rd Page of 174 TOC 1st Previous Next ↓Bottom Just 93rd
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

are removed from the accounts and any gain or loss is included in operations.
Repairs and maintenance costs are expensed as incurred.

INTANGIBLE ASSETS

Intangible assets result from acquisitions that were accounted for under
the purchase method of accounting and consist of the values of identifiable
intangible assets including core technology, patents, trade names, trademarks,
OEM relationships, work force and registered users base, as well as goodwill.
Goodwill is the amount by which the cost of acquired net assets exceeded the
fair values of those net assets on the purchase date. Intangible assets are
reported at cost, net of accumulated amortization. Intangible assets are
amortized on a straight-line basis over their estimated useful lives of three to
seven years. The Company evaluates its intangible assets when events and
circumstances indicate a potential impairment. Recoverability of these assets is
assessed based on undiscounted expected cash flows from these assets,
considering a number of factors, including past operating results, budgets and
economic projections, market trends and product development cycles. An
impairment in the carrying value of each asset is assessed when the undiscounted
expected cash flows derived from the asset are less than its carrying value (see
Note 11).

RESEARCH AND DEVELOPMENT COSTS

Costs incurred in the research and development of new software products and
enhancements to existing products, other than certain software development costs
that qualify for capitalization, are expensed as incurred. Software development
costs incurred subsequent to the establishment of technological feasibility, but
prior to the general release of the product, are capitalized and amortized to
cost of revenue over the estimated useful life of the related products. In the
years ended December 31, 2001, 2000 and 1999, costs eligible for capitalization
were not material.

INCOME TAXES

Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect in the years in which the differences are expected
to reverse. A valuation allowance against deferred tax assets is recorded if,
based on the weight of available evidence, it is more likely than not that some
or all of the deferred tax assets will not be realized. The Company does not
provide for United States income taxes on the undistributed earnings of its
foreign subsidiaries, which the Company considers to be permanent investments.

COMPREHENSIVE LOSS

Comprehensive loss consists of net loss and other comprehensive loss, which
includes foreign currency translation adjustments. For the purposes of
comprehensive loss disclosures, the Company does not record tax provisions or
benefits for the net changes in the foreign currency translation adjustment, as
the Company intends to permanently reinvest undistributed earnings in its
foreign subsidiaries.

CONCENTRATION OF RISK

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash equivalents, and trade
accounts receivable. The Company places its cash and cash equivalents with
financial institutions with high credit ratings. The Company performs ongoing
credit evaluations of its customers' financial condition and does not require
collateral, since management does not anticipate nonperformance of payment. The
Company also maintains reserves for potential credit losses and such losses have
been within management's expectations. At December 31, 2001, three customers
represented 16%, 13% and 11%, of our net accounts receivable balance,
respectively. At December 31, 2000, two customers in aggregate accounted for
50%, of our net accounts receivable balance.

F-11

424B1 94th Page of 174 TOC 1st Previous Next ↓Bottom Just 94th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS

Financial instruments include cash equivalents, accounts receivable,
short-term bank borrowings and long-term notes payable and are carried in the
financial statements at amounts that approximate their fair value as of December
31, 2001 and 2000.

ADVERTISING COSTS

Advertising costs are expensed as incurred and are classified as selling,
general and administrative costs. The Company reported advertising costs of $2.5
million, $1.9 million and $1.0 million for the years ended December 31, 2001,
2000 and 1999, respectively.

NET LOSS PER SHARE

Basic loss per share is based on the weighted average number of common
shares outstanding excluding unvested restricted stock, and diluted loss per
share is based on the weighted average number of common shares outstanding and
dilutive potential common shares outstanding. Potential common shares result
from the assumed exercise of outstanding stock options and warrants as well as
unvested shares of restricted stock and conversion of Series B Preferred Stock,
the proceeds of which are then assumed to have been used to repurchase
outstanding common stock using the treasury stock method. There is no difference
between basic and diluted net loss per share for all periods presented since
potential common shares were anti-dilutive for all periods presented. Potential
common shares, including stock options, unvested restricted stock, preferred
shares and warrants at December 31, 2001, 2000 and 1999 were approximately
17,450,100, 16,428,900 and 8,009,700, respectively.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company accounts for stock-based awards to employees using the
intrinsic value method as prescribed in Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. The Company follows the disclosure provisions of Statement of
Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation
(see Note 6). Deferred compensation is recorded for restricted stock granted to
employees based on the fair value of the Company's common stock at the date of
grant and is amortized over the period in which the restrictions lapse. All
stock-based awards to non-employees are accounted for at their fair value in
accordance with SFAS No. 123 and related interpretations.

RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141 ("SFAS 141"), Business Combinations and
No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets. SFAS 141 requires
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. SFAS 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets,
including how goodwill and other intangible assets should be accounted for after
they have been initially recognized. In addition, SFAS 142 includes provisions
for the reclassification of certain existing recognized intangible assets, such
as acquired workforce, into goodwill. SFAS 142 provides that goodwill and
intangible assets that have indefinite useful lives not be amortized but rather
be tested at least annually for impairment; intangible assets with finite useful
lives will continue to be amortized over their useful lives. SFAS 142 also
provides specific guidance for testing goodwill for impairment. In accordance
with its provisions, the Company will adopt SFAS 142 on January 1, 2002 and will
cease amortizing goodwill; the Company had previously been recording annual
goodwill amortization of approximately $10.1 million. The Company will also
reclassify approximately $0.1 million of previously recognized acquired
workforce to goodwill and as a result, amortization on this amount has also
ceased. SFAS 142 also requires the Company to complete a transitional goodwill
impairment test with-in six

F-12

424B1 95th Page of 174 TOC 1st Previous Next ↓Bottom Just 95th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

months from the date of adoption. The Company currently does not expect to
record an impairment charge on the $65.2 million of goodwill at December 31,
2001, upon completion of the initial impairment review. The decrease in
amortization expense from the goodwill will be partly offset in 2002 by the
amortization of intangible assets acquired from L&H of approximately $2.0
million per year. The Company estimates total amortization expense for 2002 will
be approximately $11.2 million.

In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS
144"). The objectives of SFAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of ("SFAS 121"), and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 supersedes SFAS 121; however, it retains
the fundamental provisions of SFAS 121 for (1) the recognition and measurement
of the impairment of long-lived assets to be held and used and (2) the
measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes
the accounting and reporting provisions of Accounting Principles Board No. 30,
Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions ("APB 30"), for segments of a business to be disposed
of. However, SFAS 144 retains the requirement of APB 30 that entities report
discontinued operations separately from continuing operations and extends that
reporting requirement to "a component of an entity" that either has been
disposed of or is classified as "held for sale." SFAS 144 also amends the
guidance of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to eliminate the exception to consolidation for a temporarily
controlled subsidiary. SFAS 144 is effective for financial statements issued for
fiscal years beginning after December 15, 2001, including interim periods, and,
generally, its provisions are to be applied prospectively. The Company does not
expect that the initial application of SFAS 144 will have a material impact on
its financial position or results of operations.

In November 2001, the Emerging Issues Task Force ("EITF"), a committee of
the FASB, reached a consensus on EITF Issue 01-9, Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products ("EITF
01-9"). EITF 01-9 presumes that consideration from a vendor to a customer or
reseller of the vendor's products is a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a reduction of
revenue when recognized in the vendor's income statement and could lead to
negative revenue under certain circumstances. Revenue reduction is required
unless consideration relates to a separate identifiable benefit and the
benefit's fair value can be established, in which case such amounts may be
recorded as operating expenses. In accordance with its provisions, the Company
will adopt EITF 01-9 on January 1, 2002. Certain of its co-operative marketing
and marketing development fund programs do not meet the criteria to be recorded
as operating expenses, which is the current policy. Unless the Company is able
to renegotiate or otherwise change these marketing programs with its retailers,
amounts earned by the retailers under such programs will be recorded as revenue
reductions in the future. Upon adoption, the Company will reclassify all prior
period reported results of operations to conform to the presentation required by
EITF 01-9. The Company is currently assessing the impact of EITF 01-9 on its
previously reported revenue and operating expenses. EITF 01-9 will not impact
its overall results of operations.

F-13

424B1 96th Page of 174 TOC 1st Previous Next ↓Bottom Just 96th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. BALANCE SHEET COMPONENTS

The following table summarizes key balance sheet components (in thousands):

[Download Table]

DECEMBER 31,
------------------
2001 2000
-------- -------

Inventory:
Raw materials............................................. $ 107 $ 324
Finished goods............................................ 400 482
-------- -------
$ 507 $ 806
======== =======
Goodwill and other intangible assets (see Note 11):
Goodwill.................................................. $ 83,509 $60,447
Patents and core technology............................... 46,456 28,586
Completed technology...................................... 16,340 16,340
Trademarks................................................ 7,461 4,383
Non-competition agreement................................. 4,048 4,048
Acquired favorable lease.................................. 553 553
OEM relationships......................................... 1,100 1,100
Assembled workforce....................................... 374 923
Other..................................................... 200 200
-------- -------
160,041 116,580
Accumulated amortization.................................. (51,509) (24,529)
-------- -------
$108,532 $92,051
======== =======
Accrued expenses:
Accrued compensation...................................... $ 2,775 $ 1,188
Accrued sales and marketing incentives.................... 1,160 1,880
Accrued restructuring..................................... 634 1,428
Accrued royalties......................................... 750 650
Accrued professional fees................................. 571 638
Accrued acquisition liabilities........................... 6,065 --
Accrued transaction costs................................. 882 --
Accrued taxes and other................................... 1,634 1,634
-------- -------
$ 14,471 $ 7,418
======== =======

[Enlarge/Download Table]

DECEMBER 31,
USEFUL LIFE ---------------
(IN YEARS) 2001 2000
----------- ------ ------

Property and equipment:
Computers, software and equipment...................... 3 $6,300 $5,391
Leasehold improvements................................. 2-4 436 505
Furniture and fixtures................................. 3 193 534
Construction in process................................ -- 176 --
--- ------ ------
7,105 6,430
Accumulated depreciation................................. (4,955) (3,476)
------ ------
$2,150 $2,954
====== ======

F-14

424B1 97th Page of 174 TOC 1st Previous Next ↓Bottom Just 97th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Depreciation expense, associated with property and equipment, for the years
ended December 31, 2001, 2000 and 1999 was $1.8 million, $2.1 million, and $0.2
million, respectively.

4. DEBT

On March 14, 2000, the Company entered into a one year Credit Agreement
(the "Agreement") with its primary financial institution for a $10,000,000
revolving loan (the "Credit Facility"). Borrowings under the Credit Facility
bore interest at the prime rate plus one percent and, as amended, expired on
September 30, 2001. The maximum aggregate amount of borrowings outstanding at
any one time as amended was $5.0 million.

During 2001, the Company repaid all amounts due under the Credit Facility,
which included principal and interest amounting to $3.4 million. The Credit
Facility was terminated and cancelled upon the final payment.

PROMISSORY NOTES PAYABLE

In connection with the L&H acquisition, the Company issued a $3.5 million
promissory note (the "Note") to L&H. The unsecured Note, matures on December 15,
2004 and bears interest at 9% per annum. Payments of principal and interest in
the amount of $133,000 are due quarterly commencing on March 15, 2002, for a
total of eleven (11) payments. All remaining principal and interest is due on
December 15, 2004.

Principal payments due under the Note are as follows: $0.2 million in 2002,
$0.2 million in 2003, and $3.1 million in 2004.

5. STOCKHOLDERS' EQUITY

PREFERRED STOCK

The Company is authorized to issue up to 40,000,000 shares of preferred
stock, par value $0.001 per share. The Company has designated 100,000 shares as
Series A Preferred Stock and 15,000,000 as Series B Preferred Stock. In
connection with the acquisition of ScanSoft (see Note 11), the Company issued
3,562,238 shares of Series B Preferred Stock to Xerox Corporation ("Xerox"). The
Series B Preferred Stock is convertible into shares of common stock on a
one-for-one basis. The Series B Preferred Stock has a liquidation preference of
$1.30 per share plus all declared but unpaid dividends. The Series B Preferred
Stock holders are entitled to non-cumulative dividends at the rate of $0.05 per
annum per share, payable when, as and if declared by the Board of Directors. To
date no dividends have been declared by the Board of Directors. Holders of
Series B Preferred Stock have no voting rights, except those rights provided
under Delaware law. The undesignated shares of preferred stock will have rights,
preferences, privileges and restrictions, including voting rights, dividend
rights, conversion rights, redemption privileges and liquidation preferences, as
shall be determined by the Board of Directors upon issuance of the preferred
stock. The Company has reserved 3,562,238 shares of its common stock for
issuance upon conversion of the Series B Preferred Stock.

COMMON STOCK WARRANTS

In connection with the ScanSoft acquisition in 1999 (see Note 11), the
Company issued employee stock options for the purchase of 1,736,630 shares of
common stock in exchange for Xerox stock options previously held by the
employees. Also in connection with the acquisition of ScanSoft, the Company
issued to Xerox a ten-year warrant that allows Xerox to acquire a number of
shares of common stock equal to the number of stock options (whether vested or
unvested) that remains unexercised at the expiration of any ScanSoft employee
stock option issued by the Company in the merger. The exercise
F-15

424B1 98th Page of 174 TOC 1st Previous Next ↓Bottom Just 98th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

price for each warrant share is $0.61. If all of the assumed ScanSoft employee
stock options expire without being exercised, Xerox would be entitled to
purchase 1,736,630 shares of common stock. The stock options, and therefore the
related warrant to Xerox, have a fixed exercise price, number of shares and
exercise period. The fair value of the stock options, determined using the
Black-Scholes model, was recorded as additional purchase consideration. As the
Xerox warrant is only exercisable upon forfeiture of the right by the employee,
the stock options and warrant were treated as one option initially exercisable
by the employee and then exercisable by Xerox. As a result, there was no
separate value or accounting for the warrant. From the date of acquisition
through December 31, 2001, 520,413 ScanSoft options have been forfeited and
accordingly, the Xerox warrant at December 31, 2001 was exercisable for the
purchase of 520,413 shares of the Company's common stock.

STOCK REPURCHASE PROGRAM

During 2001, the Board of Directors authorized the repurchase of up to 2
million shares of common stock for a period of one year ending on August 22,
2002. Purchases have been and will be made in the open market or in privately
negotiated transactions. Repurchased shares are available for issuance under
employee stock plans or in the ordinary course of business. For the year ended
December 31, 2001 the Company repurchased 656,000 shares of common stock at a
cost of $1.0 million.

OTHER

During December 2001, the Company issued 262,200 shares of its common stock
in partial settlement of a $2.1 million liability assumed in connection with the
Caere acquisition. The common stock was valued at $0.7 million based on the fair
value of the common stock on the date agreement was reached. The Company also
agreed to pay $0.7 million in cash as part of the settlement. The Company
realized a gain on this settlement of $0.7 million as a reduction of general and
administrative expenses in 2001.

On December 21, 2001, the Company committed to issuing 65,100 shares of its
common stock in partial settlement of a $1.0 million liability incurred as part
of the Caere acquisition. The common stock was valued at $0.3 million based on
the fair value of the common stock on the date agreement was reached. The
Company also agreed to pay $0.3 million in cash as part of the settlement. The
Company realized a gain on this settlement of $0.3 million as a reduction of
general and administrative expenses in 2001. The $0.3 million value of the
common stock is reflected in other long-term liabilities at year-end as the
shares were not issued as of December 31, 2001.

6. STOCK COMPENSATION PLANS

STOCK OPTION AND AWARD PLANS

The Company has several stock-based compensation plans under which
employees, officers, directors and consultants may be granted stock awards or
options to purchase the Company's common stock generally at the fair market
value on the date of grant. Stock plans were amended in June, 2000 to allow for
options to be granted only at or above fair market value. Options become
exercisable over various periods, typically two to four years and have a maximum
term of 10 years. At December 31, 2001, 17,409,583 shares were authorized for
grant under the Company's stock-based compensation plans, of which 4,192,414
were available for future grant. To date, all stock options have been granted
with exercise prices equal to the fair market value of the Company's common
stock on the date of grant.

During 2001, the Company awarded 133,824 shares of restricted common stock
to senior executives at a weighted average fair value at the grant date of $2.72
resulting in deferred compensation of $291,000. Restrictions lapse over a period
of 1 to 4 years depending on the grant. The restricted stock awards entitle the
participant to full dividend and voting rights. Unvested shares are restricted
as to disposition and

F-16

424B1 99th Page of 174 TOC 1st Previous Next ↓Bottom Just 99th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

subject to forfeiture under certain circumstances. Deferred compensation expense
is amortized to compensation expense over the period that the restrictions
lapse. During 2001, compensation expense of $15,000 was recognized. No
restricted stock awards were outstanding for the years ended December 31, 2000
and 1999, respectively.

The following table summarizes activity under all stock option plans and
for options granted outside the plans:

[Download Table]

WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- --------

Balance at December 31, 1998................................ 2,551,903 $2.4607
Options granted............................................. 3,344,392 $2.4886
Options granted in exchange for ScanSoft options............ 1,736,630 $0.6100
Options exercised........................................... (371,230) $0.6419
Options canceled............................................ (3,082,858) $1.8685
----------
Balance at December 31, 1999................................ 4,178,837 $2.7695
Options granted............................................. 7,453,007 $2.2604
Options granted in exchange for Caere options............... 4,577,993 $2.5057
Options exercised........................................... (307,307) $0.9703
Options canceled............................................ (3,536,878) $2.7977
----------
Balance at December 31, 2000................................ 12,365,652 $2.4863
Options granted............................................. 3,891,021 $2.3866
Options exercised........................................... (527,582) $1.9562
Options canceled............................................ (2,511,922) $3.2688
----------
Balance at December 31, 2001................................ 13,217,169 $2.3315
==========

The weighted average grant date fair value per share of options granted was
$1.92, $1.83 and $1.40 for the years ended December 31, 2001, 2000 and 1999,
respectively.

The following table summarizes information about stock options outstanding
under the Company's stock compensation plans at December 31, 2001:

[Enlarge/Download Table]

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
EXERCISE SHARES REMAINING AVERAGE SHARES AVERAGE
PRICE RANGE OUTSTANDING LIFE IN YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
----------- ----------- ------------- -------------- ----------- --------------

$0.41 --
$1.21 1,485,028 8.00 $0.73 649,775 $0.60
1.23 --
1.28 1,911,037 8.93 1.26 1,058,210 1.27
1.31 --
1.34 2,807,750 1.51 1.34 1,836,426 1.34
1.41 --
1.72 1,483,326 7.77 1.62 492,460 1.63
1.78 --
3.04 1,401,558 7.89 2.57 847,079 2.56
3.10 --
4.00 1,430,437 7.53 3.47 584,745 3.45
4.13 --
4.30 1,596,327 8.38 4.28 378,815 4.24
4.45 --
5.87 990,852 7.67 5.14 574,304 5.11
5.93 --
5.93 70,854 6.41 5.93 70,854 5.93
5.94 --
5.94 40,000 8.20 5.94 10,000 5.94
---------- ---------
0.41 --
5.94 13,217,169 6.68 $2.33 6,502,668 $2.19
========== =========

F-17

424B1 100th Page of 174 TOC 1st Previous Next ↓Bottom Just 100th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1995 EMPLOYEE STOCK PURCHASE PLAN

The Company's 1995 Employee Stock Purchase Plan, as amended on June 29,
1999, authorizes the issuance of a maximum of 1,000,000 shares of common stock
in semi-annual offerings to employees at a price equal to the lower of 85% of
the closing price on the applicable offering commencement date or 85% of the
closing price on the applicable offering termination date. The Company issued
95,952, 46,896 and 60,786 shares of common stock under this plan during the
years ended December 31, 2001, 2000 and 1999 respectively. The weighted average
fair value of common stock on the grant date was $0.71, $1.08 and $1.28 during
the years ended December 31, 2001, 2000 and 1999 respectively.

PRO FORMA INFORMATION

Had compensation expense for the Company's stock-based compensation plans
been determined based on fair market value at the grant dates, as prescribed by
SFAS No. 123, the Company's net loss and pro forma net loss and the Company's
net loss and pro forma net loss per share would have been as follows (in
thousands, except per share amounts):

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------

Net loss -- as reported............................... $(16,877) $(53,251) $(2,748)
Net loss -- pro forma................................. (21,897) (57,419) (5,004)
Net loss per share -- as reported: basic and
diluted............................................. (0.34) (1.26) (0.11)
Net loss per share -- pro forma: basic and diluted.... (0.44) (1.36) (0.20)

The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
expected volatility of 130% for 2001 and 2000, and 209% for 1999, risk-free
interest rate of 3.66% to 4.97% for options granted in 2001, 5.02% to 6.68% for
options granted in 2000, and 5.36% to 6.07% for options granted in 1999, and a
weighted average expected option term of 5 years for all periods. The Company
has not paid dividends to date and assumed no dividend yield.

For the Employee Stock Purchase Plan, the fair value of each purchase right
was estimated at the beginning of the offering period using the Black-Scholes
option-pricing model with the following assumptions used in 2001, 2000 and 1999:
expected volatility of 133% to 168% for 2001, 128% for 2000 and 100% to 130% for
1999; risk-free interest rate of 3.41% to 5.04%, 6.10% and 5.03% for 2001, 2000
and 1999, respectively; and expected lives of six months for all three years.
The Company has not paid dividends and assumed no dividend yield. The
weighted-average fair value of all purchase rights granted in 2001, 2000 and
1999, were $1.04, $1.73 and $0.66, respectively.

F-18

424B1 101st Page of 174 TOC 1st Previous Next ↓Bottom Just 101st
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

The Company has various operating leases for office space around the world.
These obligations extend through 2008. Future minimum payments under operating
leases with an initial term of more than one year are as follows (in thousands):

[Download Table]

YEAR ENDING DECEMBER 31,
------------------------

2002........................................................ $1,736
2003........................................................ 1,820
2004........................................................ 1,779
2005........................................................ 1,767
2006........................................................ 1,408
Thereafter.................................................. 400
------
Total....................................................... $8,910
======

Total rent expense under operating leases for the years ended December 31,
2001, 2000 and 1999 was $0.8 million, $0.8 million and $0.3 million,
respectively.

LITIGATION AND OTHER CLAIMS

Like many companies in the software industry, we have from time to time
been notified of claims that we may be infringing certain intellectual property
rights of others. These claims have been referred to counsel, and they are in
various stages of evaluation and negotiation. If it appears necessary or
desirable, we may seek licenses for these intellectual property rights. We can
give no assurance that licenses will be offered by all claimants, that the terms
of any offered licenses will be acceptable to us 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 us.

In January 2002, ScanSoft received notice that the Massachusetts Institute
of Technology and Electronics For Imaging, Inc. had filed a patent infringement
claim against 94 defendants including ScanSoft. Damages are sought in an
unspecified amount. To date, we have not yet been served with the court
documents. We cannot predict the outcome of the claim, nor can we make any
estimate of the amount of damages, if any, for which we will be held responsible
in the event of a negative conclusion of the claim.

On August 16, 2001, ScanSoft was 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.

The Company believes that the final outcome of such matters will not have a
significant adverse effect on the Company's financial position and results of
operations, including the expenditure of a significant amount of resources
defending such claims. However, should the Company not prevail in any such
litigation, its operating results and financial position could be adversely
impacted.

8. 401(K) SAVINGS PLAN

The Company has established a retirement savings plan under Section 401(k)
of the Internal Revenue Code (the "401(k) Plan"). The 401(k) Plan covers
substantially all employees of the Company who meet minimum age and service
requirements, and allows participants to defer a portion of their annual
compensation on a pre-tax basis. The Company contributes in cash, 100% of up to
the first 4% of

F-19

424B1 102nd Page of 174 TOC 1st Previous Next ↓Bottom Just 102nd
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

an employee's salary contributed to the 401(k) Plan by the employee. The
Company's contributions to the 401(k) Plan totaled $0.4 million, $0.4 million
and $0.3 million for the years ended December 31, 2001, 2000 and 1999,
respectively.

9. SEGMENT, GEOGRAPHIC AND SIGNIFICANT CUSTOMER INFORMATION

The Company operates in a single segment. The following table presents
total revenue information by geographic area (in thousands):

[Download Table]

YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

United States........................................... $50,405 $39,965 $24,732
Other foreign countries................................. 13,450 9,090 6,897
------- ------- -------
Total................................................. $63,855 $49,055 $31,629
======= ======= =======

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 Europe. Intercompany sales are insignificant as products
sold in other countries are sourced within Europe.

A number of the Company's North American OEM partners distribute its
products throughout the world but because its partners do not provide the
geographic dispersion of its products it has recognized the revenue in the
United States.

The following table summarizes the Company's long-lived assets, excluding
intangible assets, by geographic location (in thousands):

[Download Table]

DECEMBER 31,
---------------
2001 2000
------ ------

United States............................................... $2,165 $3,505
Other foreign countries..................................... 662 561
------ ------
$2,827 $4,066
====== ======

In 2001, three customers accounted for 28%, 15% and 11% of total net
revenues. During 2000, three customers accounted for 27%, 11% and 12% of total
revenues. During 1999, three customers accounted for 24%, 15% and 15% of total
revenues.

10. INCOME TAXES

The components of the income tax provision (benefit) are as follows (in
thousands):

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------

Federal..................................................... $ (16) $ -- $ 70
Foreign................................................... 277 382 60
State..................................................... (578) 90 20
----- ---- ----
Provision (benefit) for income taxes................... $(317) $472 $150
===== ==== ====

F-20

424B1 103rd Page of 174 TOC 1st Previous Next ↓Bottom Just 103rd
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For financial reporting purposes, loss before income taxes includes the
following components (in thousands):

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------

United States......................................... $(17,797) $(53,609) $(2,756)
Foreign............................................... 603 830 158
-------- -------- -------
Total............................................ $(17,194) $(52,779) $(2,598)
======== ======== =======

The cumulative amount of undistributed earnings of foreign subsidiaries,
which is intended to be permanently reinvested and for which United States
income taxes have not been provided, totaled approximately $1.2 million at
December 31, 2001.

Deferred tax assets (liabilities) consist of the following (in thousands):

[Download Table]

DECEMBER 31,
-------------------
2001 2000
-------- --------

Deferred tax assets
Net operating loss carryforwards.......................... $ 36,439 $ 40,450
Federal and state credit carryforwards.................... 4,011 3,213
Capitalized start-up and development costs................ 1,108 1,091
Accrued expense and other reserves........................ 3,374 4,007
Deferred revenue.......................................... 1,136 1,136
Depreciation.............................................. 1,960 1,697
Other..................................................... 4 5
-------- --------
Gross deferred tax assets................................. 48,032 51,599
Deferred tax liabilities
Acquired intangibles...................................... (7,767) (14,622)
Valuation allowance......................................... (40,265) (36,977)
-------- --------
Net deferred tax assets................................ $ -- $ --
======== ========

At December 31, 2001 and 2000, the Company provided a valuation allowance
for the full amount of its net deferred tax assets due to the uncertainty of
realization of those assets as a result of the recurring and cumulative losses
from operations.

The Company monitors the realization of its deferred tax assets based on
changes in circumstances, for example, recurring periods of income for tax
purposes following historical periods of cumulative losses or changes in tax
laws or regulations. At such time that changes occur which will result in a
change in the estimate of the valuation allowance, an income tax benefit would
be recorded in the results of operations to reduce the valuation allowance.

F-21

424B1 104th Page of 174 TOC 1st Previous Next ↓Bottom Just 104th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of the Company's effective tax rate to the statutory
federal rate is as follows:

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
-----------------------
2001 2000 1999
----- ----- -----

Federal statutory tax rate.................................. (34.0)% (34.0)% (34.0)%
Nondeductible amortization and in-process research and
development............................................... 20.0 5.3 51.6
Foreign taxes............................................... (0.4) 0.4 2.3
State tax, net of federal benefit........................... (4.4) 0.1 0.5
Other....................................................... 0.5 -- --
Change in valuation allowance............................... 16.5 29.1 (14.6)
----- ----- -----
(1.8)% 0.9% 5.8%
===== ===== =====

At December 31, 2001 and 2000, the Company had federal net operating loss
carryforwards of approximately $90 million and $105 million, respectively, of
which approximately $4.1 million and $2.8 million, respectively, relate to tax
deductions from stock compensation. The tax benefit related to the stock
compensation, when realized, will be accounted for as additional paid-in capital
rather than as a reduction of the provision for income tax. At December 31, 2001
the Company had federal and state research and development credit carryforwards
of approximately $2.8 million and $1.6 million respectively. The net operating
loss and credit carryforwards will expire at various dates through 2021, if not
utilized. Utilization of the net operating losses and credits may be subject to
a substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

11. ACQUISITIONS

ACQUISITION OF L&H ASSETS

On December 7, 2001, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and intellectual
property relating to the former L&H entities that were in bankruptcy under the
jurisdiction of both the United States Bankruptcy Court for the District of
Delaware and the Belgium Court of Ieper. We purchased these assets in a closed
auction proceeding and approved by both the United States and Belgium courts on
December 11, 2001. The transaction was completed on December 12, 2001 and the
Company's results from operations include L&H activities since that date.

Pursuant to the Purchase Agreement, the Company acquired patents,
trademarks, tradenames, product and customer contracts associated with certain
of the speech and language technology assets of L&H. In addition, the Company
obtained rights to accounts receivable related to the customer contracts
acquired and fixed assets. The Company also hired 223 employees from L&H. The
Company paid $41.3 million in total consideration to the creditors as follows:
$10.0 million in cash, 7.4 million shares of the Company's common stock valued
at $27.8 million (based on the average of the closing share price of our stock 3
days before and after the proposed acquisition was announced) and a 9%
promissory note in the principal amount of $3.5 million, to be repaid in
installments of $0.1 million of principal and interest quarterly commencing on
March 15, 2002, for a total of eleven (11) payments. All remaining principal and
interest shall become due on December 15, 2004. The Company incurred
approximately $1.0 million of acquisition related costs.

The purchase price was allocated to the tangible and intangible assets
acquired (patent and core technology, trade names and trademarks, and workforce)
and liabilities assumed based on their respective

F-22

424B1 105th Page of 174 TOC 1st Previous Next ↓Bottom Just 105th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

fair market values. The total identifiable tangible and intangible assets
amounted to $21.2 million. The excess purchase price of $23.0 million has been
allocated to identifiable long-lived assets based on their respective
percentages of fair value. The purchase price including acquisition costs was
allocated as follows (in thousands):

[Download Table]

Identified intangible assets................................ $20,970
Net current liabilities assumed............................. (1,976)
Fixed assets................................................ 275
-------
$19,269
=======

The values of the patents, core technology and trade names and trademarks
were determined using the income approach. The income approach requires a
projection of revenues and expenses specifically attributed to the intangible
assets. The discounted cash flow ("DCF") method is then applied to the potential
income streams after making necessary adjustments with respect to such factors
as the wasting nature of the identifiable intangible assets and the allowance of
a fair return on the net tangible assets and other intangible assets employed.
There are several variations on the income approach, including the relief-
from-royalty method, the avoided cost method and the lost profits method. The
relief-from-royalty method was used to value the patents, core technology and
trade names and trademarks. The relief-from-royalty method is used to estimate
the cost savings that accrue to the owner of the intangible assets that would
otherwise have to pay royalties or licensee fees on revenues earned through the
use of the asset. The royalty rate used in the analysis is based on an analysis
of empirical, market-derived royalty rates for guideline intangible assets.

Typically, revenue is projected over the expected remaining useful life of
the intangible asset. The market-derived royalty rate is then applied to
estimate the royalty savings. The key assumptions used in valuing the patents
and core technology are as follows: royalty rate 5%, discount rate 15%, tax rate
40% and estimated life of 10 years. The key assumptions used in valuing the
trade names and trademarks are as follows: observed royalty rate 1%, discount
rate 15%, tax rate 40% and estimated life of 12 years.

OEM contracts and customer relationships, as well as completed technology,
were determined to have de minimus values and, accordingly, no amount of the
purchase price was allocated to these intangible assets. A discounted cash flow
method was used to estimate the residual cash flows attributable to OEM
contracts and customer relationships. The projections included negative cash
flows over the early years of the relationship and, when combined with the
contributory asset charged for the other technology-based assets, such as
patents and core technology which are required to realize revenue under these
arrangements, resulted in de minimus value for the OEM contracts and the
customer relationships. The completed technology was valued using individual
cash flow projections for each technology, adjusted for capital charges, and
discounted to present value using a weighted average cost of capital. Cash flow
projections and operating profits are negative for the initial years and when
considered with the short life cycle of the application-based completed
technology, the value ascribable to the completed technology was de minimus.

F-23

424B1 106th Page of 174 TOC 1st Previous Next ↓Bottom Just 106th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table identifies the intangible assets acquired in connection
with L&H and their respective lives:

[Enlarge/Download Table]

AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------

Patents and core technology................................. $17,870 10
Trade names and trademarks.................................. 3,100 12
-------
$20,970
=======

In connection with the acquisition, we assumed certain liabilities for
products which were sold prior to the acquisition date and which are expected to
be upgraded with newer versions in 2002 and liabilities for development
contracts with customers. The actual amount of the liabilities may differ from
the estimated amounts. Differences between the actual and estimated amounts will
be recorded as an adjustment to the liability.

CAERE ACQUISITION

On March 13, 2000, the Company acquired all of the outstanding capital
stock of Caere Corporation, a California-based company that designed, developed
and marketed a range of optical character recognition software tools, for
approximately $48.5 million in cash, 19.0 million shares of common stock of the
Company valued at $98.5 million, and the issuance of stock options for the
purchase of approximately 4.6 million shares of the Company's common stock
valued at $15.5 million, in exchange for outstanding employee stock options of
Caere. The fair value of the employee stock options was estimated using the
Black-Scholes option pricing model. In addition, pursuant to a concurrent
non-competition agreement and subject to certain other conditions, the Company
agreed to pay in cash the former Caere President and CEO on the second
anniversary of the merger, March 13, 2002, the difference between $13.50 and the
closing price per share of ScanSoft common stock at that time, multiplied by
486,548. The value of this stock price guarantee at the date of acquisition was
approximately $4.1 million and has been included in the total purchase price of
the acquisition (see Note 15). Additionally, in conjunction with the
acquisition, the Company incurred approximately $1.8 million of acquisition
related costs. The purchase price of Caere, including acquisition costs was
allocated as follows (in thousands):

[Download Table]

Property and equipment...................................... $ 2,865
Current and other tangible assets........................... 58,400
Liabilities assumed......................................... (16,985)
Goodwill.................................................... 61,095
Core technology............................................. 17,905
Developed technology........................................ 16,340
Other identified intangible assets.......................... 10,448
Acquired in-process research and development................ 18,291
--------
$168,359
========

The amounts allocated to identifiable tangible and intangible assets,
including acquired in-process research and development, were based on the fair
value of the assets. Goodwill represents the amount by which the cost of
acquired net assets exceeded the fair values of those net assets on the date of
purchase. Acquired in-process research and development represented development
projects that had not yet reached technological feasibility and had no
alternative future use. Accordingly, the amount of $18.3 million was charged to
operations upon consummation of the acquisition.

F-24

424B1 107th Page of 174 TOC 1st Previous Next ↓Bottom Just 107th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The values of the core technology, developed technology and acquired
in-process technology were determined by a risk adjusted, discounted cash flow
approach. The value of in-process research and development was determined by
estimating the costs to develop the in-process projects into commercially viable
products, estimating the resulting net cash flows from the sale of such
products, discounting net cash flows back to their present values, and adjusting
those results to reflect the projects' stages of completion at the acquisition
date. These include projects (primarily major version upgrades) in each of
Caere's major products, including OmniPage, OmniForm, and PageKeeper. The
discount rates used were 14% for developed technology, 19% for core technology,
and 24% for in-process technology. The discount rate for in-process technology
takes into consideration the Company's weighted average cost of capital adjusted
for the inherent uncertainties surrounding the successful development of the
in-process research and development, the profitability levels of such technology
and the uncertainty of technological advances, which could potentially impact
the estimates described above.

The percentage of completion of the in-process projects ranged from 50% to
67% at the date of the acquisition. Revenues were initially projected to be
generated in late 2000 for each of the product versions in development at the
acquisition date. As of December 31, 2000, revenues from these projects were
expected to be generated beginning in the second quarter of 2001. All these
projects were completed during 2001.

The table following identifies the intangible assets acquired in connection
with Caere and their respective lives:

[Enlarge/Download Table]

AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------

Goodwill.................................................... $ 61,095 6
Core technology............................................. 17,905 5
Developed technology........................................ 16,340 2
Other identified intangible assets.......................... 10,448 2-5
--------
$105,788
========

Other identified intangible assets consist of a non-compete agreement,
acquired work force, a favorable building lease agreement, and patents on the
Caere technology. These assets have expected useful lives of 2, 3, 4 and 5
years, respectively, and are being amortized accordingly.

During the year ended December 31, 2000, the Company, as a result of its
June restructuring (see Note 12), wrote-off $1.1 million of acquired workforce
and $2.4 million of the favorable building lease established as part of the
identifiable intangible assets acquired from Caere. The portion of the assets
impaired related directly to the number of employees terminated and facility
space vacated in connection with these restructuring actions.

This acquisition has been accounted for under the purchase method of
accounting. Accordingly, the results of operations of Caere and the fair market
value of acquired assets and assumed liabilities have been included in the
financial statements of the Company as of the date of acquisition.

SCANSOFT ACQUISITION

On March 2, 1999, the Company acquired the business of ScanSoft, Inc., an
indirect wholly-owned subsidiary of Xerox Corporation, for approximately 6.8
million shares of common stock valued at $10.4 million, 3.6 million shares of
non-voting preferred stock valued at $4.6 million and the issuance of stock
options for the purchase of approximately 1.7 million shares of the Company's
common stock, valued

F-25

424B1 108th Page of 174 TOC 1st Previous Next ↓Bottom Just 108th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

at $2.4 million, in exchange for outstanding employee stock options of ScanSoft.
In conjunction with the acquisition, the Company incurred approximately $1.2
million of acquisition related costs.

The purchase price of $18.6 million was allocated to the tangible and
intangible assets (acquired in-process research and development, core
technology, trade mark and trade name, and assembled workforce) acquired and
liabilities assumed based on fair value. Acquired in-process research and
development represented development projects that had not yet reached
technological feasibility and had no alternative future use. Accordingly, the
amount of $3.9 million was charged to operations upon consummation of the
acquisition. The purchase price was allocated as follows (in thousands):

[Download Table]

Property and equipment...................................... $ 909
Current and other assets.................................... 4,813
Liabilities assumed......................................... (2,166)
Identified intangible assets................................ 11,096
Acquired in-process research and development................ 3,944
-------
$18,596
=======

This acquisition has been accounted for under the purchase method of
accounting. Accordingly, the results of operations of ScanSoft and the fair
value of acquired assets and assumed liabilities have been included in the
financial statements of the Company as of the date of acquisition.

The values of the core technology and acquired in-process technology were
determined by a risk adjusted, discounted cash flow approach. The value of
in-process research and development, specifically, was determined by estimating
the costs to develop the in-process projects into commercially viable products,
estimating the resulting net cash flows from the sale of such products,
discounting net cash flows back to their present values, and adjusting those
results to reflect the projects' stages of completion at the acquisition date.
These projects include projects (primarily major version releases) in each of
ScanSoft's major products, including ScanWorks, Pagis, TextBridge and API. The
discount rate used for the core technology and in-process technology was 20% and
25%, respectively. This discount rate takes into consideration the Company's
weighted-average cost of capital adjusted for the inherent uncertainties
surrounding the successful development of the in-process research and
development, the profitability levels of such technology and the uncertainty of
technological advances, which could potentially impact the estimates described
above. The percentage of completion of the projects ranged from 73% to 95% at
the date of acquisition. All of the projects were successfully completed in
1999.

The following table identifies the intangible assets acquired in connection
with ScanSoft and their respective lives:

[Enlarge/Download Table]

AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------

Core technology............................................. $ 8,747 6
Trademark................................................... 1,800 7
Workforce................................................... 549 3
-------
$11,096
=======

ACQUISITION OF METACREATIONS PRODUCT LINES

On June 30, 1999, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") and license agreement (the "License") to
acquire and license certain assets and intellectual property relating to the
photo imaging software products business of MetaCreations Corporation

F-26

424B1 109th Page of 174 TOC 1st Previous Next ↓Bottom Just 109th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

("MetaCreations"), which include Kai's PhotoSoap 1.0 and 2.0, Kai's SuperGOO
1.0, Kai's PowerGOO 1.0 and Kai's Power SHOW 1.1 (the "Products").

Pursuant to the Purchase Agreement, the Company purchased all
MetaCreations' inventory, intangibles, marketing materials and website content
relating to the Products. Under the License Agreement, MetaCreations granted the
Company a perpetual non-exclusive, royalty free license to use, reproduce,
license, sell and distribute the intellectual property relating to the Products
and other related software technology. The Company paid MetaCreations an
aggregate of $1.0 million in cash and issued a 7% promissory note in the
principal amount of $1.6 million, due and paid in full on June 30, 2000.
Additionally, the Company assumed the obligations to fulfill sales orders
relating to the Products, all liabilities under all original equipment
manufacturer and other agreements pertaining to the Products, and up to $950,000
of product returns relating to Products sold prior to the date of the Purchase
Agreement.

The purchase price was allocated to the tangible and intangible assets
(core technology, OEM relationships, trademarks, and registered users base)
acquired and liabilities assumed based on fair value. The allocation of purchase
price is estimated as follows (in thousands):

[Download Table]

Net liabilities assumed..................................... $(1,234)
Identified intangible assets................................ 3,834
-------
$ 2,600
=======

The following table identifies the intangible assets acquired in connection
with MetaCreations and their respective lives:

[Enlarge/Download Table]

AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)

Core technology............................................. $1,934 3
OEM relationships........................................... 1,100 3
Trademark and registered users.............................. 800 3
------
$3,834
======

During the fourth quarter of 2000, based on the financial results of the
MetaCreations products, the Company reviewed the estimated future lives of the
MetaCreations intangible assets. As a result of this review, the Company reduced
the future amortization period of these intangible assets with lives greater
than three years at December 31, 2000, to three years, resulting in increased
amortization of $248,000 per year over the remaining lives.

PRO FORMA RESULTS (UNAUDITED)

The following table reflects unaudited pro forma results of operations of
the Company assuming that the acquisition of ScanSoft and Caere had occurred on
January 1, 1999 (in thousands, except per share data):

[Enlarge/Download Table]

YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
-------- -------- --------

Revenues........................................... $ 94,699 $ 58,956 $ 93,299
Net loss........................................... $(53,803) $(45,098) $(21,248)
Net loss per diluted share......................... $ (0.95) $ (1.05) $ (0.46)

These unaudited pro forma results of operations do not include the hardware
business or the write-off of acquired in-process research and development as
these amounts were non-recurring in nature. The

F-27

424B1 110th Page of 174 TOC 1st Previous Next ↓Bottom Just 110th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

ADOPTION OF SFAS 142

Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets or SFAS 142.
SFAS 142 requires, among other things, the discontinuance of goodwill
amortization. The standard also includes provisions for the reassessment of the
useful lives of existing recognized intangible assets and the identification of
reporting units for purposes of assessing potential future impairments of
goodwill. SFAS 142 required the Company to complete a transitional goodwill
impairment test within six months of the date of adoption. The Company
reassessed the useful lives of its existing intangible assets, other than
goodwill, and concluded that the original useful lives remain appropriate. In
addition, the Company determined that it operates in one reporting unit and,
therefore, has completed the goodwill impairment test on an enterprise-wide
level as of January 1, 2002. Based on this analysis, the Company determined that
goodwill recorded was not impaired, and no impairment charge has been recorded.

The following summary reflects the consolidated results of operations as if
the amortization provisions of SFAS 142 had been adopted at the beginning of the
periods presented (in thousands, except net loss per share amounts):

[Enlarge/Download Table]

YEARS ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
-------- -------- -------

Net loss:
Reported net loss................................. $(16,877) $(53,251) $(2,748)
Effect of goodwill amortization................... 10,389 9,601 152
-------- -------- -------
Adjusted net loss................................. $ (6,488) $(43,650) $(2,596)
======== ======== =======
Basic net loss per share:
Reported basic net loss per share................. $ (0.34) $ (1.26) $ (0.11)
Effect of goodwill amortization................... 0.21 0.23 0.01
-------- -------- -------
Adjusted basic net loss per share................. $ (0.13) $ (1.03) $ (0.10)
======== ======== =======
Diluted net loss per share:
Reported diluted net loss per share............... $ (0.13) $ (1.03) $ (0.10)
======== ======== =======

12. RESTRUCTURING AND OTHER CHARGES

In connection with the acquisition of Caere in the first quarter of 2000,
ScanSoft identified 46 employees of Caere whose positions were eliminated upon
consummation of the acquisition. These positions included 22 in research and
development, 14 in general and administrative functions, and 10 in sales and
marketing. Additionally, the Caere president and CEO position was eliminated. As
a result, ScanSoft established as part of the purchase price allocation, a
restructuring reserve of $0.5 million for severance payments to employees, and a
restructuring reserve of $1.1 million for severance to the Caere former
president and CEO, the payments of which will continue through March 2005.

In June 2000, ScanSoft implemented a restructuring plan to strategically
refocus our business and bring operating expenses in line with net revenues. As
a result, the Company eliminated 65 employee positions including 29 in research
and development, 13 in general and administrative functions and 23 in support
and marketing. ScanSoft recorded a restructuring charge in the amount of $1.1
million for

F-28

424B1 111th Page of 174 TOC 1st Previous Next ↓Bottom Just 111th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 Los Gatos
facility. Additionally, ScanSoft wrote-off $3.5 million of net intangible assets
acquired as part of the Caere acquisition including the acquired work force of
$1.1 million and the favorable building lease of $2.4 million, which were
impaired as a result of the restructuring action.

For the years ended December 31, 2001 and 2000, ScanSoft paid $0.8 million
and $1.1 million, respectively in severance payments related to these
restructuring actions. The remaining severance balance of $0.6 million primarily
relates to severance for the former Caere President and CEO and will be paid
through March 2005.

The Company was obligated to pay retention bonuses amounting to
approximately $0.8 million and $0.2 million relating to key employees who were
employed in the Caere integration and restructuring of the companies,
respectively. These retention bonuses were expensed as incurred and were not
included in the purchase price of the acquisition. As of December 31, 2000, the
Company had paid all of these bonuses.

During the fourth quarter of 2000, the Company incurred an additional $0.3
million of facility related exit costs related to leasehold improvements on the
Los Gatos facility in space vacated by the Company. Additionally, during the
fourth quarter the Company reversed $0.4 million of restructuring accruals taken
in June 2000. Facility related contracts accounted for $0.3 million of the
reserve. The remaining $0.1 million related to severance accruals for employees
who left the Company prior to being eligible to receive severance benefits.

The following table sets forth the 2001 and 2000 restructuring reserve
activity (in thousands):

[Download Table]

LEASE INTANGIBLE
EMPLOYEE EXIT ASSET
RESTRUCTURING AND OTHER CHARGES RESERVE RELATED COSTS IMPAIRMENT TOTAL
--------------------------------------- -------- ----- ---------- -------

Restructuring reserve provided in March 2000
acquisition............................... $ 1,552 $ 1,552
Restructuring and other charges for June
2000 restructuring........................ 1,069 $ 397 $ 3,490 4,956
Additional Restructuring charges for June
2000 restructuring........................ 276 276
Reversal of excess restructuring charges
related to June 2000 restructuring........ (73) (347) (420)
Non-cash write-off.......................... (276) (3,490) (3,766)
Cash payments............................... (1,120) (1,120)
------- ----- ------- -------
Balance at December 31, 2000................ 1,428 50 -- 1,478
Cash payments............................... (794) (50) (844)
------- ----- ------- -------
Balance at December 31, 2001................ $ 634 $ -- $ -- $ 634
======= ===== ======= =======

Pursuant to the disposal of the hardware business and acquisition of the
software business of ScanSoft, the Company initiated restructuring actions in
the first quarter of 1999 and recorded a charge of $346,000 for such actions.
All planned restructuring actions were completed and all related liabilities
were paid in 1999.

F-29

424B1 112th Page of 174 TOC 1st Previous Next ↓Bottom Just 112th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. RELATED PARTIES

At December 31, 2001, Xerox owned approximately 19% of the Company's
outstanding common stock and all of the Company's outstanding Series B Preferred
Stock. In addition, Xerox has the opportunity to acquire additional shares of
common stock pursuant to a warrant (see Note 5). The Company and Xerox have
entered into multiple non-exclusive agreements in which the Company grants Xerox
the royalty-bearing right to copy and distribute certain versions of the
Company's software programs with Xerox's multi-function peripherals. Xerox
accounted for 11%, 12% and 15% of total revenues during each of the years ended
December 31, 2001, 2000 and 1999, respectively. As of December 31, 2001 and
2000, Xerox owed the Company $1.8 million and $1.6 million, respectively,
pursuant to these agreements.

On September 13, 1999, the Company purchased 600,000 shares of Series A
Preferred Stock, par value $0.10 per share, at a cost of $0.25 per share for a
total investment of $150,000 in BookmarkCentral.com (which was recently renamed
EchoBahn.com, Inc.). One of the Company's former directors, is a founder and the
current President and Chief Executive Officer of EchoBahn. During 2001, the
Company wrote-off its cost basis investment, in EchoBahn as a result of factors
which indicated the investment was impaired.

14. SALE OF HARDWARE BUSINESS

On January 6, 1999 the Company sold the assets, liabilities and
intellectual property related to the former hardware business to Primax for
approximately $6.8 million in cash. The Company reported a non-operating gain of
$0.9 million related to the sale of the hardware business, net of costs and
expenses of disposing of the business.

15. SUBSEQUENT EVENTS

On March 5, 2002, the Company negotiated an agreement with the former Caere
President and CEO to terminate the non-competition agreement entered into in
connection with the Caere acquisition (see Note 11). Under the terms of the
termination agreement, the calculation date for payments due as well as the
expiration date of options to purchase 829,000 shares of common stock were
accelerated to February 12, 2002. The resulting total cash payment will be paid
as follows: $1.0 million immediately with the remainder payable in equal
quarterly installments of approximately $0.4 million over the next two years.
The final consideration under the termination agreement will result in a
reduction of additional-paid-in capital of approximately $4.3 million in fiscal
2002 and will have no effect on the results of operations.

F-30

424B1 113th Page of 174 TOC 1st Previous Next ↓Bottom Just 113th
SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. QUARTERLY DATA (UNAUDITED)

The following information has been derived from unaudited consolidated
financial statements that, in the opinion of management, include all recurring
adjustments necessary for a fair presentation of such information.

[Enlarge/Download Table]

FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
-------- -------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

2001
Revenue........................... $ 12,801 $ 15,078 $17,066 $18,910 $ 63,855
Net loss.......................... $ (6,900) $ (4,395) $(3,214) $(2,368) $(16,877)
Earnings per share:
Basic........................... $ (0.15) $ (0.09) $ (0.06) $ (0.04) $ (0.34)
Diluted......................... $ (0.15) $ (0.09) $ (0.06) $ (0.04) $ (0.34)
Weighted average common shares
outstanding:
Basic........................... 46,100 48,939 50,875 52,858 49,693
Diluted......................... 46,100 48,939 50,875 52,858 49,693

2000
Revenue........................... $ 7,415 $ 13,975 $13,638 $14,027 $ 49,055
Net loss.......................... $(23,938) $(16,028) $(7,076) $(6,209) $(53,251)
Earnings per share:
Basic........................... $ (0.78) $ (0.35) $ (0.15) $ (0.13) $ (1.26)
Diluted......................... $ (0.78) $ (0.35) $ (0.15) $ (0.13) $ (1.26)
Weighted average common shares
outstanding:
Basic........................... 30,529 45,918 45,963 46,032 42,107
Diluted......................... 30,529 45,918 45,963 46,032 42,107

F-31

424B1 114th Page of 174 TOC 1st Previous Next ↓Bottom Just 114th
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and
Stockholders of ScanSoft, Inc:

Our audits of the consolidated financial statements referred to in our
report dated February 11, 2002, except as to Note 15 for which the date is March
5, 2002, appearing in this Registration Statement on Form S-1 of ScanSoft, Inc.
also included an audit of the financial statement schedule listed in the index
on page F-1 of such Registration Statement. In our opinion, the financial
statement schedule presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts
February 11, 2002

F-32

424B1 115th Page of 174 TOC 1st Previous Next ↓Bottom Just 115th
SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

ACCOUNTS RECEIVABLE

[Enlarge/Download Table]

2001 2000 1999
------- ------ --------
(IN THOUSANDS)

Balance at beginning of period.............................. $ 7,375 $3,690 $ 4,171
Additions charged to costs and expenses..................... 186 726 9,305
Additions charged to other accounts......................... (1,185)(a) 3,116(a) 987
Deductions and write-offs................................... (103) (157) (10,773)
------- ------ --------
Balance at end of period.................................... $ 6,273 $7,375 $ 3,690
======= ====== ========

---------------

(a) Amounts recorded against revenue representing estimates of potential future
product returns and price protection and rebate offers as of December 31,
2001 and 2000, respectively.

F-33

424B1 116th Page of 174 TOC 1st Previous Next ↓Bottom Just 116th
SCANSOFT, INC.

UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2002 AND DECEMBER 31, 2001 AND FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001

F-34

424B1 117th Page of 174 TOC 1st Previous Next ↓Bottom Just 117th
SCANSOFT, INC.

CONSOLIDATED BALANCE SHEETS

[Enlarge/Download Table]

SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE DATA)

ASSETS
Current Assets:
Cash and cash equivalents................................. $ 14,382 $ 14,324
Accounts receivable, less allowances of $7,650 and $6,273,
respectively........................................... 15,868 12,464
Receivables from related party............................ 1,238 1,802
Inventory................................................. 1,562 507
Prepaid expenses and other current assets................. 2,853 1,614
--------- ---------
Total current assets................................... 35,903 30,711
Goodwill.................................................. 63,308 65,231
Other intangible assets, net.............................. 36,035 43,301
Property and equipment, net............................... 2,933 2,150
Other assets.............................................. 1,091 677
--------- ---------
TOTAL ASSETS................................................ $ 139,270 $ 142,070
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... 5,541 5,320
Accrued expenses.......................................... 11,695 14,471
Deferred revenue.......................................... 955 1,375
Note payable.............................................. 227 227
Other current liabilities................................. 1,720 --
--------- ---------
Total current liabilities.............................. 20,138 21,393
Deferred revenue............................................ 278 2,534
Long-term note payable, net of current portion.............. 3,101 3,273
Other liabilities........................................... 819 336
--------- ---------
Total liabilities...................................... 24,336 27,536
--------- ---------
Commitments and contingencies (Note 10, 11 and 12)
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; 65,334,366 and 62,754,211 shares issued and
63,216,988 and 62,098,211 shares outstanding,
respectively........................................... 65 63
Additional paid-in capital................................ 269,822 264,893
Treasury stock, at cost; 2,117,378 and 656,000 shares,
respectively........................................... (8,031) (1,031)
Deferred compensation..................................... (199) (276)
Accumulated other comprehensive income (loss)............. 12 (487)
Accumulated deficit....................................... (151,366) (153,259)
--------- ---------
Total stockholders' equity............................. 114,934 114,534
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $ 139,270 $ 142,070
========= =========

The accompanying notes are an integral part of these consolidated financial
statements.
F-35

424B1 118th Page of 174 TOC 1st Previous Next ↓Bottom Just 118th
SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

[Enlarge/Download Table]

NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2002 2001
---------- -----------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
(UNAUDITED)

Revenue, third parties...................................... $74,598 $ 38,773
Revenue, related party...................................... 3,586 5,357
------- --------
Total revenue............................................. 78,184 44,130
------- --------
Costs and expenses:
Cost of revenue........................................... 12,937 9,215
Cost of revenue from amortization of intangible assets.... 7,494 10,536
Research and development.................................. 21,310 10,016
Selling, general and administrative....................... 32,051 18,944
Amortization of goodwill and other intangible assets...... 1,446 9,964
Restructuring and other charges........................... 1,041 --
------- --------
Total costs and expenses.................................... 76,279 58,675
------- --------
Income (loss) from operations............................... 1,905 (14,545)
Other income (expense), net................................. (178) (126)
------- --------
Income (loss) before income taxes........................... 1,727 (14,671)
Provision for (benefit from) income taxes................... (166) (162)
------- --------
Net income (loss)........................................... $ 1,893 $(14,509)
======= ========
Net income (loss) per share: basic.......................... $ 0.03 $ (0.30)
======= ========
Net income (loss) per share: diluted........................ $ 0.03 $ (0.30)
======= ========
Weighted average common shares: basic....................... 67,116 48,638
======= ========
Weighted average common shares: diluted..................... 72,451 48,638
======= ========

The accompanying notes are an integral part of these consolidated financial
statements.
F-36

424B1 119th Page of 174 TOC 1st Previous Next ↓Bottom Just 119th
SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

[Download Table]

NINE MONTHS ENDED
SEPTEMBER 30,
------------------
2002 2001
------- --------
(IN THOUSANDS)
(UNAUDITED)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 1,893 $(14,509)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.......................... 1,535 1,395
Allowances for returns and bad debts................... 1,246 (1,460)
Amortization of intangible assets...................... 8,940 20,500
Non-cash portion of restructuring and other charges.... 113 --
Gain on disposal or sale of property and equipment..... (30) (89)
Deferred compensation.................................. 77 --
Changes in operating assets and liabilities, net of
effects of acquisitions:
Accounts receivable.................................. (4,234) (147)
Inventory............................................ (1,003) 335
Prepaid expenses and other assets.................... (1,189) 613
Other assets......................................... (273) --
Accounts payable..................................... (292) (799)
Accrued expenses..................................... 2,162 (1,117)
Deferred revenue..................................... (2,682) 1,371
------- --------
Net cash provided by operating activities................... 6,263 6,093
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment........... (2,090) (563)
Proceeds from sale of property and equipment.............. 42 344
Payments of acquisition-related liabilities............... (2,360) --
Cash paid for acquisition................................. (500) --
Other..................................................... -- 62
------- --------
Net cash used in investing activities....................... (4,908) (157)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term borrowings......................... -- (3,400)
Payments of capital lease obligation...................... (238) --
Purchase of treasury stock................................ (7,000) (521)
Payments of notes payable related to acquisition.......... (586) --
Payments under deferred payment agreement................. (1,824) --
Proceeds from private placement of common stock, net of
issuance costs......................................... 5,690 4,995
Proceeds from the issuance of common stock upon exercise
of options............................................. 2,545 --
------- --------
Net cash provided by (used in) financing activities......... (1,413) 1,074
------- --------
Effects of exchange rate changes on cash and cash
equivalents............................................... 116 (312)
------- --------
Net increase in cash and cash equivalents................... 58 6,698
Cash and cash equivalents at beginning of period............ 14,324 2,571
======= ========
Cash and cash equivalents at end of period.................. $14,382 $ 9,269
======= ========
Supplemental disclosure of noncash investing activities:
Shares issued in connection with the purchase of assets
(Note 5).................................................. $ 600 $ --
======= ========

The accompanying notes are an integral part of these consolidated financial
statements.
F-37

424B1 120th Page of 174 TOC 1st Previous Next ↓Bottom Just 120th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of ScanSoft,
Inc. (the "Company", "we" 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, 2002 and 2001 and
the results of operations and cash flows for the nine months ended September 30,
2002 and 2001. 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 pursuant to the rules and regulations of the Securities and Exchange
Commission. The accompanying financial statements should be read in conjunction
with the audited financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 filed
with the Securities and Exchange Commission on April 1, 2002.

The results for the nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002, or any future period. Certain prior year financial statement
amounts have been reclassified to conform with the current year presentation.

Royalty revenue derived from sales to OEM partners is recognized when
software copies are deployed and payment is due. Royalty revenue from OEM
customers with whom the Company has significant past experience is recognized
based on estimated deployments in the respective period. Differences between
estimates and actual deployments are recorded as an adjustment to revenue in the
following quarter. These estimates have been based on timely, informal
communications with the OEMs and the past payment and royalty reporting history
of the OEMs, seasonality of the OEM's business, the number of copies deployed in
prior periods and the overall economic climate in which the OEMs operate.

For the quarters ended June 30, 2001, March 31, 2002 and June 30, 2002,
differences between the actual and estimated deployments resulted in differences
between reported and actual revenue of $(0.5) million, $(0.3) million and $0.3
million, respectively, with a corresponding impact on operating and net
income/(loss) for such periods. The Company deemed that these differences would
not have a material impact on the results of operations for the years ending
December 31, 2001 and December 31, 2002, respectively.

The Company believes that it can more accurately determine OEM revenue
based on reports of actual deployments received from OEM customers. While
historically the Company has been unable to obtain OEM deployment reports prior
to reporting financial results, the Company now believes it is in a position to
obtain such reports on a timely basis. Therefore, beginning with the fourth
quarter of 2002, the Company intends to report OEM revenue based on actual
deployments as reported by OEM customers.

424B1 121st Page of 174 TOC 1st Previous Next ↓Bottom Just 121st
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

transaction as an acquisition of assets. As previously disclosed, the Company
had ongoing discussions with the SEC regarding historical financial statement
requirements related to the acquisition. Following these discussions, the
Company concluded that, for purposes of Rule 3-05 of Regulation S-X, the L&H
transaction was an acquisition of a business and not an acquisition of assets.
In connection with these discussions, the Company also concluded that the
transaction should be reported as the acquisition of a business for accounting
purposes rather than the acquisition of assets, as previously reported. On
August 14, 2002, the Company filed a Form 10-Q/A to restate the financial
statements as of and for the quarter ended March 31, 2002 to reflect the impact
of the change in the accounting for the acquisition. As a result of the change
in accounting, $23.0 million of the purchase price previously allocated to
tangible and other intangible assets has been reclassified to goodwill and
amortization expense has been reduced by $0.6 million. The restatement had no
material effect on the financial position or results of operations as of or for
the year ended December 31, 2001.

A summary of the impact of this restatement on the consolidated financial
statements as of and for the unaudited three-month period ended March 31, 2002
is as follows:

[Enlarge/Download Table]

THREE MONTHS ENDED
MARCH 31, 2002
---------------------------
AS PREVIOUSLY
REPORTED AS RESTATED
(IN THOUSANDS, EXCEPT PER SHARE DATA) ------------- -----------

Statement of Operations:
Amortization of goodwill and other intangible assets...... $ 5,111 $ 4,499
Loss from operations...................................... (3,213) (2,601)
Net loss.................................................. $(3,494) $(2,882)
Net loss per share -- basic and diluted................... $ (0.06) $ (0.05)

[Enlarge/Download Table]

MARCH 31, 2002
---------------------------
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------

Balance Sheet:
Goodwill, net............................................. $ 42,200 $ 65,231
Other intangible assets, net.............................. 62,638 40,476
Property and equipment, net............................... 2,838 2,582
Accumulated deficit....................................... (156,753) (156,141)

2. RECENT ACCOUNTING PRONOUNCEMENTS

In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
144). The objectives of SFAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121), and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 supersedes SFAS 121; however, it retains
the fundamental provisions of SFAS 121 for (1) the recognition and measurement
of the impairment of long-lived assets to be held and used and (2) the
measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes
the accounting and reporting provisions of Accounting Principles Board No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" (APB 30), for segments of a business to be disposed of.
However, SFAS 144 retains the requirement of APB 30 that entities report
discontinued operations

F-39

424B1 122nd Page of 174 TOC 1st Previous Next ↓Bottom Just 122nd
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

separately from continuing operations and extends that reporting requirement to
"a component of an entity" that either has been disposed of or is classified as
"held for sale." SFAS 144 also amends the guidance of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a temporarily controlled subsidiary. SFAS 144 is effective
for financial statements issued for fiscal years beginning after December 15,
2001, including interim periods, and, generally, its provisions are to be
applied prospectively. The Company adopted the provisions of SFAS 144 in 2002
and its adoption had no impact on its financial position or results of
operations.

In November 2001, the Emerging Issues Task Force ("EITF"), a committee of
the FASB, reached a consensus on EITF Issue 01-9, "Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)"
(EITF 01-9). EITF 01-9 presumes that consideration from a vendor to a customer
or reseller of the vendor's products is a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a reduction of
revenue when recognized in the vendor's income statement and could lead to
negative revenue under certain circumstances. Revenue reduction is required
unless consideration relates to a separate identifiable benefit and the
benefit's fair value can be established, in which case such amounts may be
recorded as operating expenses. The Company implemented EITF 01-9 on January 1,
2002. The implementation resulted in a $0.3 million reduction to net revenue and
a corresponding reduction to selling, general and administrative expenses for
the nine months ended September 30, 2002. Additionally, it resulted in the
reclassification of $0.8 million from selling, general and administrative
expenses to net revenue for the nine months ended September 30, 2001.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). This statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF 94-3). SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. EITF 94-3 allowed for an
exit cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. The Company does not expect the adoption
of SFAS 146 will have a material impact on its financial position or results of
operations.

3. BALANCE SHEET COMPONENTS

The following table summarizes key balance sheet components (in thousands):

[Enlarge/Download Table]

SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------

Inventory:
Raw materials............................................. $ -- $ 107
Finished goods............................................ 1,562 400
------- -------
$ 1,562 $ 507
======= =======
Other accrued expenses:
Accrued compensation...................................... $ 2,483 $ 2,775
Accrued sales and marketing............................... 1,566 1,160
Accrued restructuring..................................... 732 634
Accrued royalties......................................... 491 750

F-40

424B1 123rd Page of 174 TOC 1st Previous Next ↓Bottom Just 123rd
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

[Enlarge/Download Table]

SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------

Accrued professional fees................................. 525 571
Accrued acquisition liabilities........................... 1,800 6,065
Accrued income taxes and other............................ 4,098 2,516
------- -------
$11,695 $14,471
======= =======

During the nine months ended September 30, 2002, the Company entered into
settlement agreements related to certain contractual liabilities assumed in
connection with the acquisition of the majority of the speech and language
technology operations of L&H (L&H acquisition), which occurred on December 12,
2001. Upon settlement of these liabilities, $1.9 million of the assumed
liabilities recorded at the date of acquisition were reversed with a
corresponding reduction recorded to the carrying value of goodwill.

4. GOODWILL AND OTHER INTANGIBLE ASSETS

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 142 (SFAS 142), "Goodwill and Other
Intangible Assets." SFAS 142 addresses financial accounting and reporting for
acquired goodwill and other intangible assets, including how goodwill and other
intangible assets should be accounted for after they have been initially
recognized. SFAS 142 provides that goodwill and intangible assets that have
indefinite useful lives not be amortized but rather be tested at least annually
for impairment; intangible assets with finite useful lives will continue to be
amortized over their useful lives.

The Company adopted SFAS 142 on January 1, 2002 and discontinued the
amortization of goodwill (including acquired workforce) of approximately $65.2
million. Upon adoption, the Company reclassified $31,000 of previously
amortizable acquired workforce to goodwill. The Company had previously been
recording amortization expense on goodwill and acquired workforce of $10.4
million annually or $2.6 million per quarter.

Under SFAS 142, the Company was required to complete a transitional
impairment test on all goodwill effective as of January 1, 2002 on a reporting
unit basis. A reporting unit is defined as an operating segment or one level
below an operating segment referred to as a component. A component of an
operating segment is a reporting unit if the component constitutes a business
and discrete financial information is prepared and regularly reviewed by
management. The Company determined that it operates in one reporting unit and,
therefore, has completed the transitional goodwill impairment test on an
enterprise-wide basis.

SFAS 142 provides for a two-step impairment test to identify potential
goodwill impairment. The first step of the goodwill impairment test compares the
fair value of a reporting unit with its carrying value, including goodwill. If
the fair value of a reporting unit exceeds its carrying value, goodwill of the
reporting unit is considered not impaired, thus the second step of the
impairment test, which determines the amount of goodwill impairment, is
unnecessary.

The fair value of the reporting unit was determined using the Company's
market capitalization as of January 1, 2002. As the fair value of the reporting
unit as of January 1, 2002 was in excess of the carrying amount of the net
assets, the Company concluded that its goodwill was not impaired, and no
impairment charge was recorded. The Company will complete additional goodwill
impairment analyses at least annually or more frequently when events and
circumstances occur indicating that the recorded goodwill might be impaired. The
Company will perform its annual assessment during the fourth quarter of 2002.

F-41

424B1 124th Page of 174 TOC 1st Previous Next ↓Bottom Just 124th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Intangible assets are amortized on a straight-line basis over their
estimated useful lives of three to twelve years. As required, upon adoption of
SFAS 142, the Company reassessed the useful lives of its intangible assets and
has determined that no adjustments were required.

The following summary reflects the consolidated results of operations as if
SFAS 142 had been adopted at the beginning of the periods presented (in
thousands, except net income (loss) per share amounts):

[Download Table]

NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
------ --------

Net income (loss):
Reported net income (loss)................................ $1,893 $(14,509)
Effect of goodwill amortization........................... -- 7,790
------ --------
Adjusted net income (loss)................................ $1,893 $ (6,719)
====== ========
Basic net income (loss) per share:
Reported basic net income (loss) per share................ $ 0.03 $ (0.30)
Effect of goodwill amortization........................... -- .16
------ --------
Adjusted basic net income (loss) per share................ $ 0.03 $ (0.14)
====== ========
Diluted net income (loss) per share:
Reported diluted net income (loss) per share.............. $ 0.03 $ (0.30)
Effect of goodwill amortization........................... -- .16
------ --------
Adjusted diluted net income (loss) per share.............. $ 0.03 $ (0.14)
====== ========

Other intangible assets consist of the following (in thousands):

[Enlarge/Download Table]

GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------

SEPTEMBER 30, 2002
Patents and core technology.................... $48,130 $17,343 $30,787
Completed technology........................... 16,340 16,340 --
Trademarks..................................... 7,461 2,573 4,888
Non-competition agreement...................... 4,048 4,048 --
Acquired favorable lease....................... 553 553 --
OEM relationships.............................. 1,100 740 360
Other.......................................... 200 200 --
------- ------- -------
$77,832 $41,797 $36,035
======= ======= =======
DECEMBER 31, 2001
Patents and core technology.................... $46,456 $11,771 $34,685
Completed technology........................... 16,340 14,714 1,626
Trademarks..................................... 7,461 1,784 5,677
Non-competition agreement...................... 4,048 3,646 402
Acquired favorable lease....................... 553 355 198

F-42

424B1 125th Page of 174 TOC 1st Previous Next ↓Bottom Just 125th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

[Enlarge/Download Table]

GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------

OEM relationships.............................. 1,100 524 576
Assembled workforce............................ 374 270 104
Other.......................................... 200 167 33
------- ------- -------
$76,532 $33,231 $43,301
======= ======= =======

The balances of patents and core technology, trademarks and assembled
workforce at December 31, 2001 reflect the impact of the restatement described
in Note 1. As a result of the restatement $16.6 million and $2.9 million and
$3.3 million of patents and core technology, trademarks and assembled workforce,
respectively, were reallocated to goodwill.

Aggregate amortization expense was $8.9 million ($7.5 included in cost of
revenue) for the nine months ended September 30, 2002. Estimated amortization
expense for each of the five succeeding fiscal years as of September 30, 2002 is
as follows (in thousands):

[Download Table]

YEAR ENDING AMOUNT
----------- -------

Remainder of 2002........................................... $ 2,212
2003........................................................ 8,847
2004........................................................ 7,977
2005........................................................ 3,576
2006........................................................ 2,327
2007........................................................ 2,284
Thereafter.................................................. 8,812
-------
Total....................................................... $36,035
=======

5. ACQUISITION

On February 22, 2002, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and intellectual
property from L&H Holdings USA, Inc. The transaction was completed on March 21,
2002. Pursuant to the Purchase Agreement, the Company acquired patents and core
technology associated with the Audiomining assets of the speech and language
technology assets of L&H and paid $1.5 million in total consideration to L&H as
follows: $0.5 million in cash, 121,359 shares of the Company's common stock
valued at $0.6 million (based on the average of the closing share price of the
Company's stock 5 days before and after the date the transaction was completed)
and a 9% promissory note in the principal amount of $0.4 million (the "Note"),
with principal and interest to be repaid in full on July 31, 2002. The Company
incurred $0.2 million of acquisition related costs. The purchase price including
acquisition costs of $1.7 million was allocated to core technology.

On July 31, 2002, the Company repaid all amounts due under the Note, which
included principal and interest of $414,000.

6. 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

F-43

424B1 126th Page of 174 TOC 1st Previous Next ↓Bottom Just 126th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

During the nine months ended September 30, 2002, the Company paid a total
of $0.7 million in severance payments, of which $0.6 million related to the
March 2002 restructuring and $0.1 million related to severance paid to the
former Caere President and CEO, pursuant to a 2000 restructuring.

At September 30, 2002, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.7 million. This balance is
comprised of $0.2 million of lease exit costs resulting from the 2002
restructuring and $0.5 million of severance to the former Caere President and
CEO. The severance due to the former Caere President and CEO will be paid
through March 2005.

The following table sets forth activity under the 2002 and 2000
restructuring actions (in thousands):

RESTRUCTURING AND OTHER CHARGES RESERVE

[Enlarge/Download Table]

EMPLOYEE LEASE
RELATED EXIT COSTS TOTAL
-------- ---------- ------

Balance at December 31, 2001................................ $ 634 $ -- $ 634
Restructuring and other charges for March 2002
restructuring............................................. 576 465 1,041
Non cash write-offs......................................... -- (113) (113)
Cash payments............................................... (722) (108) (830)
----- ----- ------
Balance at September 30, 2002............................... $ 488 $ 244 $ 732
===== ===== ======

7. DEFERRED PAYMENT AGREEMENT

In connection with the Caere acquisition in the first quarter of 2000 and
pursuant to a concurrent non-competition and consulting agreement, the Company
agreed to pay in cash to the former Caere President and CEO, a current member of
the Board of Directors of the Company, on the second anniversary of the merger,
March 13, 2002, the difference between $13.50 and the closing price per share of
ScanSoft common stock at that time, multiplied by 486,548. On March 5, 2002, the
Company negotiated a deferred payment agreement with the former Caere President
and CEO to terminate this agreement. Under the terms of the deferred payment
agreement, the Company paid $1.0 million in cash on March 5, 2002 and agreed to
make future cash payments totaling $3.3 million, with such amounts payable in
equal quarterly installments of approximately $0.4 million over the following
two years. During the nine months ended September 30, 2002, the Company paid two
quarterly installments under this agreement totaling $0.8 million.

The total consideration of this agreement was accounted for in the original
Caere purchase price and had no effect on the results of operations. The
remaining liability at September 30, 2002 is $2.4 million, of which $1.6 million
is included in other current liabilities and $0.8 million is included in other
long-term liabilities.

8. 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 nine months ended September 30, 2002 includes the assumed
conversion of the Series B Preferred Stock, which participates in dividends with
F-44

424B1 127th Page of 174 TOC 1st Previous Next ↓Bottom Just 127th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

common stock when and if declared as well as the weighted average impact of
vested restricted stock shares. 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, 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):

[Download Table]

NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2002 2001
------ ------

Basic net income (loss) per share:
Weighted average number of common shares outstanding...... 63,554 48,638
Assumed conversion of Series B Preferred Stock............ 3,562 --
------ ------
Weighted average common shares: basic....................... 67,116 48,638
====== ======

Effect of dilutive common equivalent shares:
Stock options............................................. 4,772 --
Warrants.................................................. 468 --
Unvested restricted stock................................. 95 --
------ ------
Weighted average common shares: diluted..................... 72,451 48,638
====== ======

For the nine months ended September 30, 2002, stock options to purchase
1,655,604 shares, of common stock were outstanding but were excluded from the
calculation of diluted net income per share because the options' exercise prices
were greater than the average market price of the Company's common stock during
the period.

Potential common shares, including stock options, unvested restricted
stock, preferred shares and warrants at September 30, 2001 were approximately
16,544,500. These potential common shares were excluded from the calculation of
diluted net loss per share as their inclusion would have been antidilutive for
the period presented.

9. COMPREHENSIVE INCOME (LOSS)

Total comprehensive income (loss), net of taxes, was $2.4 million for the
nine months ended September 30, 2002, and was ($14.8) million for the nine
months ended September 30, 2001. Total comprehensive income (losses) consisted
of net income or losses and foreign currency translation adjustments for the
respective periods.

10. COMMITMENTS AND CONTINGENCIES

In December 2001, the Company was sued for patent infringement initiated by
the Massachusetts Institute of Technology and Electronics For Imaging, Inc. The
Company was one of more than 200 defendants named in this suit. Damages are
sought in an unspecified amount. The Company filed an Answer and Counterclaim on
July 1, 2002. The Company cannot predict the outcome of the claim, nor can it
make any estimate of the amount of damages, if any, for which it will be held
responsible in the event of a negative conclusion of the claim. The Company
believes this claim has no merit, and it intends to defend the action
vigorously.

F-45

424B1 128th Page of 174 TOC 1st Previous Next ↓Bottom Just 128th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As a normal incidence of the nature of the Company's business, various
claims, charges and litigation have been asserted or commenced against the
Company arising from or related to employee relations and other business
matters. Management does not believe these claims will have a material effect on
the financial position or results of operations of the Company.

11. EQUITY TRANSACTIONS

On April 12, 2002, the Company completed a private placement of 1.0 million
shares of common stock at a purchase price of $6.00 per share with SF Capital
Partners Ltd., resulting in proceeds, net of issuance costs, of $5.7 million.

In September of 2002, the Company repurchased 1,461,378 shares of common
stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech Products N.V.
(collectively, L&H) and certain other parties at $4.79 per share for a total
consideration of $7.0 million. The price per share was based on the greater of
$4.79 or the twenty day trading average beginning August 14, 2002, which was
$4.67. These shares represented a portion of the common shares that were issued
to L&H in connection with the December 12, 2001 acquisition of certain of L&H's
speech and language technology operations and the March 21, 2002 acquisition of
the AudioMining assets of L&H Holdings USA, Inc. The Company agreed to issue an
additional 150,000 shares of its common stock to L&H if it does not complete an
underwritten public offering of the shares held by L&H by December 15, 2002. The
Company further agreed to issue an additional 150,000 shares of its common stock
to L&H if it does not complete an underwritten public offering by February 15,
2003. The Company also will be required to issue an additional 100,000 shares of
its common stock to L&H if, by February 15, 2003, it fails to file a
registration statement to register the shares remaining unsold. The value
ascribed to the potential right to acquire additional shares of the Company's
common stock was valued at $0.3 million using a probability-weighted,
Black-Scholes valuation model and recorded as a credit to additional paid-in
capital, with a corresponding reduction in additional paid-in capital because
the Company has an accumulated deficit. Accordingly, the right had no net effect
on the Company's financial position or results of operations.

In connection with the agreements described above, entered into in
September 2002, the terms of the $3.5 million promissory note issued as partial
consideration for the L&H acquisition were amended to include a debt covenant.
The covenant provides for the acceleration of the maturity date of the
outstanding principal and interest to January 1, 2003 if consummation of the
underwritten public offering does 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 of the outstanding principal
and accrued interest under this note. ScanSoft will classify the debt as current
in its balance sheet at December 31, 2002.

12. SUBSEQUENT EVENTS

On October 7, 2002, the Company signed a definitive agreement with Royal
Philips Electronics (Philips) to acquire its Speech Processing Telephony and
Voice Control business units and related intellectual property. Under the
agreement, the Company will pay Philips $3.0 million in cash, issue a $4.9
million note due December 31, 2003 bearing 5.0% interest per annum and issue a
$27.5 million three-year, zero-interest debenture, convertible at any time into
shares of the Company's common stock at $6.00 per share. The Company expects to
close the transaction in the first quarter of 2003.

On October 21, 2002, the Company filed with the Securities and Exchange
Commission two registration statements. The first registration statement was
filed in connection with a proposed underwritten public offering of 7.0 million
shares of the Company's common stock, of which 6.0 million shares are being
offered by Lernout & Hauspie Speech Products N.V. and L&H Holdings USA, Inc. and
1.0 million shares are being offered by the Company. The second registration
statement provides for the
F-46

424B1 129th Page of 174 TOC 1st Previous Next ↓Bottom Just 129th
SCANSOFT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

registration of 9.0 million shares of the Company's common stock on behalf of
three large institutional investors. These shares will not be included in the
proposed underwritten public offering and are being registered pursuant to
registration rights agreements previously entered into by the Company.

On October 31, 2002, the Company entered into a two year Loan and Security
Agreement (the "Loan Agreement") with Silicon Valley Bank (the "Bank") that
consisted of a $10,000,000 revolving loan (the "Credit Facility"). Borrowings
under the Credit Facility will bear interest at the Bank's prime rate plus
0.375% or 0.75%, which is determined by the Company's fixed charge coverage
ratio, as defined in the Loan Agreement. The maximum aggregate amount of
borrowings outstanding at any one time will be limited to the lesser of
$10,000,000 or a borrowing base. The borrowing base will be equal to either 80%
or 70% of eligible accounts receivable, as defined in the Loan Agreement, which
is determined by the Company's fixed charge coverage ratio. Pursuant to the Loan
Agreement, the Company will be required to maintain certain financial and
non-financial covenants, the most restrictive of which is a quarterly minimum
fixed charge coverage ratio of 1.25 to 1.00. 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.

F-47

424B1 130th Page of 174 TOC 1st Previous Next ↓Bottom Just 130th
COMBINED FINANCIAL STATEMENTS OF THE PHILIPS SPEECH PROCESSING TELEPHONY
AND VOICE CONTROL DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.

F-48

424B1 131st Page of 174 TOC 1st Previous Next ↓Bottom Just 131st
INDEPENDENT AUDITORS' REPORT

The Supervisory Board of Royal Philips Electronics N.V.

We have audited the accompanying combined balance sheets of Philips Speech
Processing Telephony and Voice Control (A division of Royal Philips Electronics
N.V.) as of December 31, 2001 and September 29, 2002, and the related combined
statements of operations and comprehensive loss, changes in the net investment
of the Philips Group, and cash flows for the year ended December 31, 2001 and
the nine-month period ended September 29, 2002. These combined financial
statements are the responsibility of Philips Speech Processing Telephony and
Voice Control's management. Our responsibility is to express an opinion on these
combined financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Philips Speech
Processing Telephony and Voice Control (A division of Royal Philips Electronics
N.V.) as of December 31, 2001 and September 29, 2002, and the results of its
operations and its cash flows for the year ended December 31, 2001 and the
nine-month period ended September 29, 2002, in conformity with generally
accepted accounting principles in the United States of America.

/s/ KPMG ACCOUNTANTS N.V.

Eindhoven, The Netherlands
November 15, 2002

F-49

424B1 132nd Page of 174 TOC 1st Previous Next ↓Bottom Just 132nd
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL

(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

COMBINED BALANCE SHEETS

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

ASSETS
CURRENTS ASSETS:
Cash...................................................... 23 12
Accounts receivable, net (Notes 3 and 16)................. 3,036 4,580
Receivables from related parties (Note 13)................ 512 724
Inventory, net (Note 4)................................... 662 773
Deferred income taxes (Notes 9 and 13).................... 25 0
Other current assets (Note 5)............................. 240 618
TOTAL CURRENT ASSETS........................................ 4,498 6,707
------ -----
Property, plant and equipment, net (Notes 6 and 15)......... 521 388
Intangible assets, net (Note 7)............................. 184 135
------ -----
TOTAL ASSETS................................................ 5,203 7,230
====== =====

LIABILITIES AND NET INVESTMENT OF THE PHILIPS GROUP
CURRENT LIABILITIES:
Accounts payable.......................................... 850 672
Deferred income........................................... 1,481 1,141
Payables to related parties (Note 13)..................... 1,541 2,023
Deferred income tax liability (Notes 9 and 13)............ 17 17
Other accrued liabilities (Note 8)........................ 2,153 2,349
TOTAL CURRENT LIABILITIES................................... 6,042 6,202
------ -----
Long-term provisions (Note 10).............................. 269 338
TOTAL LIABILITIES........................................... 6,311 6,540
------ -----
Commitments and contingencies (Note 14).....................
NET INVESTMENT OF THE PHILIPS GROUP......................... (1,108) 690
TOTAL LIABILITIES AND NET INVESTMENT OF THE PHILIPS GROUP... 5,203 7,230
====== =====

The accompanying notes are an integral part of these combined financial
statements.
F-50

424B1 133rd Page of 174 TOC 1st Previous Next ↓Bottom Just 133rd
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL

(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

COMBINED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

[Enlarge/Download Table]

YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -----------------
IN THOUSANDS OF EURO'S

Revenue, third parties...................................... 15,801 12,548
Revenue, related parties.................................... 2,890 389
------- -------
Total revenue............................................. 18,691 12,937
------- -------
Cost of sales............................................... 3,288 1,731
GROSS PROFIT................................................ 15,403 11,206
------- -------
Operating expenses:
Selling and marketing..................................... 15,066 8,581
Research and development (Note 13)........................ 13,512 7,874
General and administrative (Note 13)...................... 3,877 2,935
Total operating expenses.................................... 32,455 19,390
OPERATING LOSS.............................................. (17,052) (8,184)
Interest revenue, net (Note 13)............................. 2 6
LOSS BEFORE INCOME TAXES.................................... (17,050) (8,178)
Income tax benefit (Note 9)................................. 1,364 245
NET LOSS.................................................... (15,686) (7,933)
======= =======
Components of other comprehensive income:
Foreign currency translation adjustments.................. 58 (95)
COMPREHENSIVE LOSS.......................................... (15,628) (8,028)
======= =======

The accompanying notes are an integral part of these combined financial
statements.
F-51

424B1 134th Page of 174 TOC 1st Previous Next ↓Bottom Just 134th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL

(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

CHANGES IN THE NET INVESTMENT OF THE PHILIPS GROUP

[Download Table]

NET INVESTMENT OF THE
PHILIPS GROUP
---------------------
IN THOUSANDS OF
EURO'S

BALANCE DECEMBER 31, 2000................................... 972
Net cash transfer from Philips.............................. 13,548
Components of comprehensive income:
Net loss.................................................. (15,686)
Foreign currency translation adjustments.................. 58
BALANCE DECEMBER 31, 2001................................... (1,108)
Net cash transfer from Philips.............................. 9,826
Components of comprehensive income:
Net loss.................................................. (7,933)
Foreign currency translation adjustments.................. (95)
BALANCE SEPTEMBER 29, 2002.................................. 690

The accompanying notes are an integral part of these combined financial
statements
F-52

424B1 135th Page of 174 TOC 1st Previous Next ↓Bottom Just 135th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL

(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

COMBINED STATEMENTS OF CASH FLOWS

[Enlarge/Download Table]

YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -----------------
IN THOUSANDS OF EURO'S

Cash flows from operating activities:
Net loss.................................................... (15,686) (7,933)
Adjustments to reconcile net income to net cash provided by
(used in) operating activities
Deferred taxation......................................... (1,260) 25
Depreciation and amortization............................. 607 266
Change in assets and liabilities:
Accounts receivable, net............................... 1,033 (1,544)
Related parties, net................................... 2 270
Inventory, net......................................... 851 (111)
Other current assets................................... 207 (378)
Accounts payable....................................... (69) (178)
Deferred income and other accrued liabilities.......... (30) (144)
Long-term provisions................................... 85 69
Effect of exchange rate changes............................. (38) (6)
NET CASH USED IN OPERATING ACTIVITIES....................... (14,298) (9,664)
Cash flows from investing activities:
Purchases of property, plant and equipment................ (201) (84)
NET CASH USED IN INVESTING ACTIVITIES....................... (201) (84)
Cash flows from financing activities:
Net cash transferred from Philips......................... 13,606 9,731
Effect of exchange rate changes............................. 4 (59)
NET CASH PROVIDED BY FINANCING ACTIVITIES................... 13,610 9,672
Effect of exchange rate changes............................. 34 65
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (855) (11)
Cash and cash equivalents, beginning of period.............. 878 23
Cash and cash equivalents, end of period.................... 23 12
Supplementary information:
Cash received from Philips for income taxes................. 9,897 105
Cash received from (paid to) Philips for interest........... (576) 2

The accompanying notes are an integral part of these combined financial
statements
F-53

424B1 136th Page of 174 TOC 1st Previous Next ↓Bottom Just 136th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND SEPTEMBER 29, 2002

1. DESCRIPTION OF THE COMPANY AND BASIS OF PRESENTATION

DESCRIPTION OF THE COMPANY

PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL (PSP), a division of
Royal Philips Electronics N.V. (Philips and Philips Group) is active in the
field of speech processing technology. Starting from the traditional
tape-recorded dictation Philips in the past two decades has become a global
leader in the field of speech processing, offering a wide portfolio of
state-of-the-art products and technologies. Philips Speech Processing Telephony
is offering speech-enabled services including directory assistance, interactive
voice response and voice portal applications for enterprise customers, telephony
vendors and carriers. Philips Speech Processing Voice Control is operating on
the market for speech-enabled automotive and mobile products. It offers a
product portfolio including small footprint speech recognition engines for
embedded applications like voice controlled climate, navigation and
entertainment features within cars as well as voice dialing within mobile
phones. With presence in Aachen, Germany, Dallas, USA, and Taipei, Taiwan PSP is
able to cover the global market with products supporting more than 40 languages
and that can process a vocabulary of more than one million words.

Royal Philips Electronics N.V., the Netherlands, and ScanSoft, Inc., of
Peabody, MA, USA entered into a purchase agreement in which ScanSoft acquires
the business, employees and intellectual property of Philips Speech Processing
Telephony and Philips Speech Processing Voice Control . The transaction is
expected to close during the first quarter of 2003. See note 17 for additional
disclosure of the transaction.

BASIS OF PRESENTATION

The combined financial statements reflect the financial position, results
of operations, changes in net investment of the Philips Group, and cash flows of
the PSP business unit of Philips as if PSP had been a separate entity for all
periods presented. The combined financial statements have been prepared using
Philips' historical basis for PSP's assets and liabilities and results of
operations, which have been stated in conformity with accounting principles
generally accepted in the United States of America (U.S. GAAP). All significant
intercompany transactions and balances have been eliminated in preparation of
the combined financial statements.

Corporate overheads have been allocated to PSP from Philips at central,
regional and local levels for amounts, including directors remuneration,
marketing, management information systems, accounting and financial reporting,
treasury, human resources, legal, tax and security, based on the net sales of
PSP compared to the consolidated net sales of Philips. Management believes these
allocations are reasonable. However, the costs of these services charged to PSP
are not necessarily indicative of the costs that would have been incurred had
PSP operated as an entity independent of Philips, or as an autonomous public
company, for all periods presented.

PSP purchases components used in the production process, as well as
equipment and supplies under collective purchase agreements and purchase
conditions negotiated by Philips. Management believes that the benefits derived
from such agreements and conditions would unlikely have been obtained had PSP
been a stand-alone company.

The pension and other postretirement benefit costs attributable to PSP have
been based on the charge incurred by individual operations in respect of
specific plans of which employees of PSP are members. For the purposes of
presentation of the combined financial statements, the participation in the
Philips plans has been treated as participation in various multi-employer plans.
The charges included in the combined financial statements reflect the
arrangements of Philips and are therefore not necessarily indicative of the
pension and other postretirement benefit costs had PSP been a stand-alone
company. During the year
F-54

424B1 137th Page of 174 TOC 1st Previous Next ↓Bottom Just 137th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

ended December 31, 2001, PSP has benefited from contribution holidays with
respect to certain over-funded Philips pension plans. During 2002 no
contribution holidays existed anymore. Upon divestment, PSP will not benefit
from any contribution holidays, as the employees will no longer participate in
Philips' plans.

Because in the past PSP was not a separate legal group of companies or a
separate holding company within the Philips Group of companies, the proportion
of share capital and reserves attributable to PSP has been shown in the combined
balance sheets as part of the "Net investment of the Philips Group". For the
purpose of these combined financial statements, interest charge is calculated
based on the average rate of interest for long-term debt paid by Philips and the
average amount of net investment of the Philips Group invested in PSP during the
reporting periods, taking into account the debt-to-equity ratio reported by
Philips during the reporting periods. In addition, PSP has a number of
short-term balances with other Philips Group businesses. These balances arise
from trading transactions and services or other items and have been aggregated
on the combined balance sheets under the headings "Receivables from related
parties" and "Payables to related parties".

Historically, PSP's operations have been included in the combined income
tax returns filed by Philips in each of the countries where PSP is located
(country fiscal unity). Income tax expense in these combined financial
statements has been calculated on an as if separate tax return basis. The
current tax expense is assumed to be settled within the financial period
following the period in which it arises. Tax effects that may arise from PSP's
divestment from the Philips Group have not been reflected in PSP's combined
financial statements.

Other significant features of the PSP divestment from Philips are described
in Note 17.

The financial information included herein is not necessarily indicative of
the combined results of operations, financial position, changes in the net
investment of the Philips Group and cash flows of PSP in the future or what they
would have been for the periods presented had PSP been a separate stand-alone
entity.

REPORTING CURRENCY

The Euro is used as reporting currency. The financial statements of foreign
operations are translated into euros. Assets and liabilities are translated
using the exchange rates on the respective balance sheet dates. Income and
expense items are translated at average rates during the period.

2. SUMMARY OF ACCOUNTING POLICIES

CASH AND CASH EQUIVALENTS

Historically, Philips manages cash and cash equivalents on a centralized
basis. Cash receipts associated with PSP's business are transferred to Philips
on a daily basis and Philips funds PSP's disbursements. These cash transactions
are reflected in the caption "Net investment of the Philips Group". In certain
countries, however, PSP has dedicated bank accounts, operating under periodic
cash pooling with Philips. Furthermore, PSP entities have small amounts of petty
cash.

ACCOUNTS RECEIVABLE

Accounts receivables are stated at face value, net of allowances for
doubtful accounts.

F-55

424B1 138th Page of 174 TOC 1st Previous Next ↓Bottom Just 138th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

INVENTORY

Finished goods inventories are valued at the lower of cost, as determined
by the first-in, first-out (FIFO) method, or net realizable value. Provision is
made for obsolescence. Work in process comprises deferred costs on uncompleted
contracts.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost, less accumulated
depreciation. Depreciation is calculated using the straight-line method over the
expected economic life of the asset. Costs related to maintenance activities are
expensed in the period in which they are incurred. Following are the expected
useful lives of the assets:

[Download Table]

Machines and installations.................................. from 5 to 10 years
Other fixed assets.......................................... from 3 to 5 years

INTANGIBLE ASSETS

Intangible assets consists of acquired intellectual property rights
consisting of computer software for resale, which is being amortized on the
straight-line method over 5 years.

IMPAIRMENT OF LONG-LIVED ASSETS

Through December 31, 2001, PSP evaluated the recoverability of its
long-lived assets in accordance with Statement of Financial Accounting Standards
(SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of". Whenever adverse events or changes in
business climate result in the expected undiscounted future cash flows from the
related asset being less than the carrying value of the asset, an impairment
loss would be recognized for the excess of the carrying value of the assets over
the expected discounted future cash flows.

On January 1, 2002, PSP adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 amends existing
guidance on asset impairment and provides a single accounting model for
long-lived assets to be disposed of. SFAS No. 144 also changes the criteria for
classifying an asset as held-for-sale; and broadens the scope of businesses to
be disposed of that qualify for reporting as discontinued operations, and
changes the timing of recognizing losses on such operations. The adoption of
SFAS No. 144 on January 1, 2002 did not have an impact on the Company's combined
financial statements.

INCOME TAXES

Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Deferred tax assets, including assets arising from loss carry
forwards, are recognized if it is more likely than not that the asset will be
realized.

F-56

424B1 139th Page of 174 TOC 1st Previous Next ↓Bottom Just 139th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION

PSP recognizes revenue in accordance with Statement of Position 97-2,
Software Revenue Recognition, 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 hardware and
software to end users is recognized upon delivery, provided that no significant
obligations remain, evidence of the arrangement exists, the fees are fixed or
determinable, and collectibility of the related receivable is reasonably
assured.

Revenue from royalties on sales of PSP's products by original equipment
manufacturers to third parties is recognized upon delivery to the third party
when such information is available, or when notified by the reseller that such
royalties are due as a result of a sale, provided that collectibility of the
related receivable is reasonably assured. Revenue from maintenance contracts is
recognized ratably over the contract term.

Revenue from development of custom software is recognized on a completed
contract basis. Accordingly, all project costs and progress payments are
deferred until the project is complete. Any anticipated losses are recognized
immediately.

RESEARCH AND DEVELOPMENT AND CAPITALIZED SOFTWARE DEVELOPMENT COSTS

Under SFAS No. 86 "Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed", costs incurred in the research and
development of software products are expensed as incurred until technological
feasibility has been established. Once established, these costs would be
capitalized. The establishment of technological feasibility and the ongoing
assessment of the recoverability of these costs requires considerable judgment
by management with respect to certain external factors, including, but not
limited to, anticipated future gross product revenues, estimated economic life
and changes in software and hardware technologies. In the year ended December
31, 2001 and the nine-month period ended September 29, 2002, costs eligible for
capitalization were not material.

PENSION AND OTHER POSTRETIREMENT BENEFITS

PSP accounts for the cost of pension plans and postretirement benefits
other than pensions in accordance with SFAS No. 87, "Employers Accounting for
Pensions" and SFAS No. 106, "Employers Accounting for Postretirement Benefits
Other Than Pensions", respectively. These plans are generally part of pension
and postretirement benefit plans within Philips, and are accounted for by PSP as
multi-employer plans.

STOCK-BASED COMPENSATION

PSP applies SFAS No. 123, "Accounting for Stock-Based Compensation", which
allows companies which have stock-based compensation arrangements with employees
to continue to apply the existing accounting required by Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and to
provide pro forma disclosure of the accounting results of applying the fair
value method of SFAS No. 123. PSP accounts for stock-based compensation
arrangements (related to Philips stock options granted to PSP employees) under
the intrinsic value method of APB Opinion No. 25.

USE OF ESTIMATES

The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect reported amounts in the
financial statements and the accompanying
F-57

424B1 140th Page of 174 TOC 1st Previous Next ↓Bottom Just 140th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

notes. While management bases its assumptions and estimates on the facts and
circumstances known at the balance sheet date, actual results could materially
differ from those estimates.

ACCOUNTING STANDARDS NOT YET ADOPTED

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No.
143 requires PSP to record the fair value of an asset retirement obligation as a
liability in the period in which it incurs a legal obligation associated with
the retirement of tangible long-lived assets that result from the acquisition,
construction, development and/or normal use of the assets. PSP also records a
corresponding asset, which is depreciated over the life of the asset. Subsequent
to the initial measurement of the asset retirement obligation, the obligation
will be adjusted at the end of each period to reflect the passage of time and
changes in the estimated future cash flows underlying the obligation. PSP is
required to adopt SFAS No. 143 on January 1, 2003. PSP believes that the
adoption of SFAS No. 143 will not have a material impact on its financial
statements.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
(SFAS No. 145). SFAS No. 145 provides for the rescission of several previously
issued accounting standards, new accounting guidance for the accounting for
certain lease modifications and various technical corrections to existing
pronouncements that are not substantive in nature. SFAS No. 145 will be adopted
on January 1, 2003, except for the provisions relating to the amendment of SFAS
No. 13, "Accounting for Leases", which will be adopted as required for
transactions occurring subsequent to May 15, 2002. PSP believes that the
adoption of SFAS No. 145 will not have a material impact on its financial
statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities" (SFAS No. 146). SFAS No. 146 addresses significant issues
regarding the recognition, measurement and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to the guidance that the Emerging
Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". The scope of
SFAS No. 146 also includes (1) costs related to terminating a contract that is
not a capital lease, and (2) termination benefits that employees who are
involuntarily terminated receive under the terms of a one-time benefit
arrangement that is not an ongoing benefit arrangement or an individual deferred
compensation contract. SFAS No. 146 is to be applied prospectively to exit or
disposal activities initiated after December 31, 2002. PSP believes that the
adoption of SFAS No. 146 will not have a material impact on its financial
statements.

3. ACCOUNTS RECEIVABLE

Accounts receivable consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Trade accounts receivable................................... 4,503 5,751
Allowance for doubtful accounts............................. (1,467) (1,171)
Total accounts receivable, net.............................. 3,036 4,580

F-58

424B1 141st Page of 174 TOC 1st Previous Next ↓Bottom Just 141st
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

4. INVENTORY

Inventory consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Work in process............................................. 606 568
Finished goods.............................................. 225 235
Allowance for obsolescence.................................. (169) (30)
Total inventory, net........................................ 662 773

5. OTHER CURRENT ASSETS

Other current assets consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Royalties receivable........................................ 22 418
Prepaid expenses and sundry receivables..................... 218 200
Total Other current assets.................................. 240 618

6. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Machines and installations.................................. 1,374 1,243
Other fixed assets.......................................... 3,730 3,805
Accumulated depreciation.................................... (4,583) (4,660)
Total property, plant and equipment, net.................... 521 388

7. INTANGIBLE ASSETS

Intangible assets consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Computer software for resale, gross......................... 230 208
Accumulated amortisation.................................... (46) (73)
Intangible asset, net....................................... 184 135

Amortization of computer software costs was E46 thousand and E27 thousand
for the year ended December 31, 2001 and the nine-month period ended September
29, 2002, respectively. The estimated amortisation expense for the next three
years is E36 thousand per year.

F-59

424B1 142nd Page of 174 TOC 1st Previous Next ↓Bottom Just 142nd
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

8. OTHER ACCRUED LIABILITIES

Other accrued liabilities consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Salaries and wages, holiday allowance, year-end payment..... 1,245 1,376
Accrued holiday rights...................................... 335 377
Obligation towards former stock holders..................... 196 177
Accrued sales tax........................................... 56 49
Accrued commercial costs.................................... 83 92
Others...................................................... 238 278
Total other accrued liabilities............................. 2,153 2,349

9. INCOME TAXES

Historically, PSP's operations have been included in the combined income
tax returns filed by Philips in each of the countries where PSP is located
(country fiscal unity). The income tax expense reported and the determination of
deferred tax assets to be realized in PSP's combined financial statements is
based on an as if separate tax return basis.

The following table presents the principal reasons for the difference
between the effective income tax rate and statutory income tax rate in the
Netherlands:

[Enlarge/Download Table]

YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 2001 SEPTEMBER 29, 2002
----------------- ------------------
IN PERCENTAGES

Statutory income tax rate in the Netherlands........ 35% 35%
Foreign rate differentials.......................... 4% 3%
Change in valuation allowance....................... (31)% (34)%
Others.............................................. 0% (1)%
Effective income tax rate........................... 8% 3%

F-60

424B1 143rd Page of 174 TOC 1st Previous Next ↓Bottom Just 143rd
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The income tax expense is as follows:

[Enlarge/Download Table]

YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 2001 SEPTEMBER 29, 2002
----------------- ------------------
IN THOUSANDS OF EURO'S

Income (loss) before income taxes:
The Netherlands................................... 0 0
Foreign........................................... (17,050) (8,178)
Income tax benefit (expense):
Current taxes
The Netherlands................................... 0 0
Foreign........................................... 105 270
Deferred taxes
The Netherlands................................... 0 0
Foreign........................................... 1,259 (25)
Income tax benefit.................................. 1,364 245

The sources of differences between the financial accounting and tax basis
of PSP's assets and liabilities that give rise to the net deferred tax assets
are as follows:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Deferred tax assets:
Doubtful accounts......................................... 84 76
Accrued compensation...................................... 131 194
Taxes other than income taxes............................. 84 20
Jubilee provision......................................... 19 21
Others.................................................... 174 144
Property, plant and equipment............................. 110 92
Net operating losses...................................... 29,436 31,330
TOTAL GROSS DEFERRED TAX ASSETS............................. 30,038 31,877
Valuation allowance......................................... (29,978) (31,842)
NET DEFERRED TAX ASSETS..................................... 60 35
Deferred tax liabilities:
Fixed assets.............................................. 27 27
Accruals.................................................. 17 17
Others.................................................... 8 8
TOTAL GROSS DEFERRED LIABILITIES............................ 52 52
NET DEFERRED TAX ASSETS (LIABILITIES)....................... 8 (17)

Based upon an as if separate tax return basis, as at September 29, 2002 PSP
has incurred E22.1 million of operating loss carry forwards expiring at various
dates through 2022 and E56.8 million of operating loss carry forwards with no
expiration date.

F-61

424B1 144th Page of 174 TOC 1st Previous Next ↓Bottom Just 144th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The valuation allowance for deferred tax assets as of December 31, 2001 and
September 29, 2002 was E30.0 million and E31.8 million, respectively. The net
change in total valuation allowance for the year ended December 31, 2001 and the
nine-month period ended September 29, 2002 was an increase of E4.1 million and
E1.8 million, respectively. In assessing the realizability of deferred tax
assets, PSP considers whether it is more likely than not that some portion or
all of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible. PSP
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies in making this assessment. Based upon
the level of historical taxable income and projections for future taxable income
over the periods in which the deferred tax assets are deductible, management
believes it is more likely than not that PSP will realize the benefits of those
deductible differences for which a valuation allowance has not been recorded.

10. LONG-TERM PROVISIONS

Long-term provisions consisted of the following:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Provision for pensions...................................... 199 265
Provision for jubilee benefit obligations................... 70 73
Total long-term provisions.................................. 269 338

11. PENSION AND OTHER POST RETIREMENT COSTS

Employees of PSP participate in various defined benefit and defined
contribution pension plans of the Philips Group. For the purposes of the
preparation of these combined financial statements, PSP's participation in the
Philips plans has been treated as participation in various multi-employer plans.
Accordingly, the charges included in the combined financial statements may not
be indicative of the pension and other post retirement costs had PSP been a
stand alone entity.

Pension premium charged for the year ended December 31, 2001 and the
nine-month period ended September 29, 2002 were E86 thousand and E102 thousand,
respectively.

In addition to receiving pension benefits, PSP employees in certain
countries participate in other postretirement benefit plans of the Philips
Group. These other postretirement benefits under SFAS No. 106 are recorded at
the country central level and charged out to the various local entities as part
of human resource overhead (surcharge on salaries paid). The charge to PSP is
approximately E13 thousand and E32 thousand for the year ended December 31, 2001
and the nine-month period ended September 29, 2002, respectively.

12. EQUITY INCENTIVE PLANS

EXISTING PHILIPS INCENTIVE PLANS

Philips has granted stock options on its ordinary shares to members of
PSP's management and certain key employees under either a Euro (EUR) denominated
plan or a United States Dollar (USD) denominated plan. Under Philips' plans,
options are granted with an exercise price equal to the fair market value of the
underlying ordinary shares on the date of grant. Options are subject to vesting
periods typically of three years and expirations of five or ten years. A limited
number of options have also been

F-62

424B1 145th Page of 174 TOC 1st Previous Next ↓Bottom Just 145th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

granted under variable plans, subject to achievement of certain financial
objectives during multi-year performance cycles. Exercise of all options is
restricted by Philips' rules on insider trading.

STOCK-BASED COMPENSATION

Pro forma net income information, as required by SFAS No. 123, has been
determined as if PSP had accounted for employee share options granted to PSP's
employees by Philips under SFAS No. 123's fair value method. The pro forma
amounts below are not necessarily representative of the effects of share-based
awards on future net income because the plans eventually adopted by PSP after
divestment from Philips may differ from Philips share options plans. Accordingly
future grants of employee stock options to PSP's employees may not be comparable
to awards made to employees while PSP was a part of Philips.

The pro forma effect of recognizing compensation expense in accordance with
SFAS No. 123 would have been as follows:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

Net loss, as reported....................................... (15,686) (7,933)
Pro forma net loss.......................................... (15,802) (8,112)

The fair value of each option was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
(EUR -- DENOMINATED)

Risk-free interest rate..................................... 4.66% 4.83%
Expected dividend yield..................................... 1.2% 1.2%
Expected option life........................................ 5 yrs. 5 yrs.
Expected stock price volatility............................. 49% 53%

[Download Table]

(USD -- DENOMINATED)

Risk-free interest rate..................................... 4.77% 4.62%
Expected dividend yield..................................... 1.2% 1.2%
Expected option life........................................ 5 yrs. 5 yrs.
Expected stock price volatility............................. 49% 49%

The assumptions were used for these calculations only and do not
necessarily represent an indication of management's expectations of future
development.

F-63

424B1 146th Page of 174 TOC 1st Previous Next ↓Bottom Just 146th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about the number of Philips
share options granted to PSP's employees, those outstanding at December 31, 2001
and September 29, 2002 and changes during the period:

Fixed option plans:

[Enlarge/Download Table]

DECEMBER 31, 2001 SEPTEMBER 29, 2002
-------------------------- -------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------- ---------------- ------ ----------------
(IN EUR) (IN EUR)

Options outstanding, beginning of
period............................. 3,200 43.18 9,325 33.77
Options granted...................... 6,125 28.85 6,336 34.78
Options exercised....................
Options forfeited....................
Options outstanding, end of period... 9,325 33.77 15,661 34.18
Weighted average fair value of
options granted during the year in
EUR................................ 14.75 16.27
(IN USD) (IN USD)
Options outstanding, beginning of
period............................. 24,500 40.61 16,700 29.57
Options granted...................... 11,950 25.68 8,892 30.70
Options exercised....................
Options forfeited.................... (19,750) 40.90 (1,250) 42.28
Options outstanding, end of period... 16,700 29.57 24,342 29.33
Weighted average fair value of
options granted during the year in
USD................................ 11.90 13.48

Variable option plans:

[Enlarge/Download Table]

Options outstanding, beginning of
period............................. 3,200 43.18 9,325 33.77
Options granted...................... 6,125 28.85
Options exercised....................
Options forfeited....................
Options outstanding, end of period... 9,325 33.77 9,325 33.77
Weighted average fair value of
options granted during the year in
EUR................................ 14.75
(IN USD) (IN USD)
Options outstanding, beginning of
period............................. 22,500 42.00 14,700 30.20
Options granted...................... 11,950 25.68
Options exercised....................
Options forfeited.................... (19,750) 40.90 (1,250) 42.28
Options outstanding, end of period... 14,700 30.20 13,450 29.08
Weighted average fair value of
options granted during the year in
USD................................ 11.90

F-64

424B1 147th Page of 174 TOC 1st Previous Next ↓Bottom Just 147th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about stock options outstanding
at September 29, 2002:

Fixed option plans:

[Enlarge/Download Table]

OPTIONS OUTSTANDING
-------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -----------------------------------
NUMBER AVERAGE NUMBER
OUTSTANDING AT REMAINING EXERCISABLE AT
SEPTEMBER 29, EXERCISE PRICE CONTRACTUAL LIFE SEPTEMBER 29, WEIGHTED PRICE PER
YEAR OF GRANT 2002 PER SHARE (YEARS) 2002 SHARE
------------- -------------- -------------- ---------------- -------------- ------------------
(PRICE IN EUR) (PRICE IN EUR)

2000................. 3,200 42.90 - 45.90 7.99 -- --
2001................. 6,125 24.35 - 29.14 8.57 -- --
2002................. 6,336 34.78 9.54 -- --
(PRICE IN USD) (PRICE IN USD)
1999................. 2,000 24.96 6.75 2,000 24.96
2000................. 3,000 36.65 - 43.05 7.71 -- --
2001................. 10,450 25.68 8.54 -- --
2002................. 8,892 30.70 9.54 -- --
TOTAL................ 40,003 2,000

Variable option plans:

[Enlarge/Download Table]

2000................. 3,200 42.90 - 45.90 7.99 -- --
2001................. 6,125 24.35 - 29.14 8.57 -- --
(PRICE IN USD) (PRICE IN USD)
2000................. 3,000 36.65 - 43.05 7.71 -- --
2001................. 10,450 25.68 8.54 -- --
TOTAL................ 22,775

F-65

424B1 148th Page of 174 TOC 1st Previous Next ↓Bottom Just 148th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

13. TRANSACTIONS WITH RELATED PARTIES

PSP sells products to and purchases certain products and services from
Philips in the normal course of business. Transactions between PSP and Philips
are effected at prices that are intended to reflect the market value of the
products and services involved. The following table summarizes transactions
between PSP and Philips:

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

STATEMENT OF OPERATIONS:
Sales to Philips group...................................... 2,890 389
Interest revenue............................................ 2 6
Corporate overhead allocation............................... 308 178
Corporate Research.......................................... 3,058 1,458

[Enlarge/Download Table]

DECEMBER 31, SEPTEMBER 29,
2001 2002
------------ -------------
IN THOUSANDS OF EURO'S

BALANCE SHEET:
Income taxes receivable (included in Receivables from
related parties).......................................... 105 270
Trade accounts receivable from Philips Group................ 512 724
Trade accounts payable to Philips Group..................... 1,541 2,023
Deferred income taxes....................................... 8 (17)

Interest revenue in these combined financial statements is calculated based
on the average rate of interest for long-term debt paid by Philips and the
average amount of net investment of the Philips Group invested in PSP during the
reporting periods, taking into account the debt-to-equity ratio reported by
Philips during the reporting periods.

Income tax expense has been calculated on an as if separate tax return
basis. Tax effects that may arise from PSP's divestment from the Philips Group
have not been reflected in PSP's combined financial statements.

Corporate overheads have been allocated to PSP from Philips at central,
regional and local levels for amounts including, but not limited to, directors
remuneration, marketing, management information systems, accounting and
financial reporting, treasury, human resources, legal, tax and security, based
on the net sales of PSP compared to the consolidated net sales of Philips.
Management believes these allocations are reasonable. However, the costs of
these services charged to PSP are not necessarily indicative of the costs that
would have been incurred had PSP operated as an entity independent of Philips.

Philips Corporate Research is contracted by PSP to perform certain research
and development projects; the projects are determined on a yearly basis. The fee
charged is reported under Research & Development expenses.

F-66

424B1 149th Page of 174 TOC 1st Previous Next ↓Bottom Just 149th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

14. COMMITMENTS AND CONTINGENCIES

PSP is potentially subject to lawsuits, claims and proceedings, which arise
in the ordinary course of business. There are no such matters pending that PSP
expects to be material in relation to its business, financial condition or
results of operations.

RENT AGREEMENTS

PSP has entered into certain short-term contracts to rent office and
warehouse facilities. The rent charged to income amounted to E1,112 thousand and
E827 thousand for the year ended December 31, 2001 and the nine-month period
ended September 29, 2002 respectively, of which E181 thousand and E201 thousand
respectively relates to charges from Philips based on square meters occupied.

The table below presents the amounts of rent payable under the present
contracts for the upcoming periods.

[Download Table]

RENT AMOUNT
-----------
IN
THOUSANDS
OF EURO'S

Remainder of year 2002...................................... 218
Year 2003................................................... 779
Year 2004................................................... 531
Year 2005................................................... 531
Year 2006................................................... 133
Year 2007 and later......................................... 0

15. GEOGRAPHICAL INFORMATION

PSP operates and derives its revenue from all major regions in the world.
The geographical location of property, plant and equipment and the geographical
origin of revenues are as follows:

[Enlarge/Download Table]

AMERICAS EUROPE ASIA PACIFIC TOTAL
-------- ------ ------------ ------
IN THOUSANDS OF EURO'S

December 31, 2001
Net sales....................................... 7,883 9,446 1,362 18,691
Property, plant and equipment, net.............. 129 378 14 521
September 29, 2002
Net sales....................................... 7,194 5,400 343 12,937
Property, plant and equipment, net.............. 60 322 6 388

16. CONCENTRATION OF RISKS AND FINANCIAL INSTRUMENTS

CONCENTRATION OF CREDIT RISK

Credit risk represents the risk that a loss would be recognized at the
reporting date if counter parties failed completely to perform as contracted.
Financial instruments which potentially subject PSP to a concentration of credit
risk consist principally of accounts receivable. Management believes it has
adequately provided for the collection risk in PSP's trade accounts receivable
by recording an allowance for doubtful accounts which reduces such amounts to
their net realizable value.

Due to the project nature of the speech processing business, PSP derives a
substantial portion of its revenues from a limited number of customers. In the
year 2001 and the nine-month period ended

F-67

424B1 150th Page of 174 TOC 1st Previous Next ↓Bottom Just 150th
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

September 29, 2002, two and three customers, respectively accounted for more
than 10% of revenues each, and in the aggregate for 28% and 32% of revenues,
respectively.

FINANCIAL INSTRUMENTS

PSP's earnings, cash flows, and financial position are exposed to foreign
currency risk from foreign currency denominated receivables, payables,
forecasted transactions, as well as net investments in certain foreign
operations. These items are denominated in various foreign currencies, including
mainly the U.S. Dollar.

PSP periodically assesses its foreign currency exchange risk exposure. As
USA customers are invoiced from Dallas, USA, in US Dollars and European
customers are invoiced from Aachen, Germany, in Euro the currency risk exposure
is very limited. Accordingly, PSP does not enter into any hedging activities or
purchase derivative instruments.

During 2001, PSP recorded a net foreign currency transaction profit of E23
thousand and during the nine-month period ended September 29, 2002, a loss was
recorded of E9 thousand, which is included in cost of sales.

FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES

The carrying values of accounts receivable and accounts payable approximate
fair value because of the short maturity of these instruments.

17. SUBSEQUENT EVENTS

On October 7, 2002, Royal Philips Electronics N.V. and ScanSoft, Inc.
signed a purchase agreement for the sale of PSP's business, assets and
liabilities. All employees of PSP are expected to be hired by ScanSoft. The
legal closing is expected to take place in the first quarter of 2003.

To provide for an orderly transfer and transition of PSP from Philips to
ScanSoft, various agreements will be executed that cover a wide range of
matters, including but not limited to:

- the transfer by Philips to ScanSoft of the business, employees, assets
and liabilities associated with PSP's business (Purchase Agreement, Local
Asset Transfer Agreements);

- the transfer or license by Philips to ScanSoft of certain intellectual
property rights (Technology Transfer and License Agreement, Trademark
Transfer and License Agreement);

- the provision by Philips of certain corporate and local human resource
management, finance and accounting, housing, information technology and
other services to ScanSoft (Transition Services Agreement).

STOCK INCENTIVE PLANS

The Philips stock options granted to the PSP employees will not be
converted into options for shares of ScanSoft. Upon closing, PSP employees with
outstanding exercisable options will have a limited period of time to exercise
these options and all unvested options will be cancelled. In addition, ScanSoft
has assumed no obligation towards the beneficiaries or towards Philips with
respect to these outstanding Philips' stock options.

F-68

424B1 151st Page of 174 TOC 1st Previous Next ↓Bottom Just 151st
PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL
(A DIVISION OF ROYAL PHILIPS ELECTRONICS N.V.)

NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

PENSIONS AND OTHER POSTRETIREMENT BENEFITS

In most countries PSP's employees have pension entitlements as part of
their benefit packages, and as it is common practice that in offering
transferring employees equivalent benefit packages, this equivalence also
extends to pension rights. In fact there exists a compulsory European Directive
obliging member states to implement legislation in each EC country to the effect
that in case of transfer of a business, all pension entitlements will transfer
with the transferred employees. In the Netherlands, this law has become
effective on July 1, 2002.

In some countries, the pension entitlements are part of a state scheme; in
many countries, however, the entitlements are specifically related to Philips,
and will require a per country approach on how to deal with pension rights going
forward and the treatment of accrued rights in the past. There are legal
requirements which will dictate a transfer of pension liabilities, but also if
there is not a strict legal requirement, in many cases taking into account the
justified interest of employees will be a precondition for a smooth transition
process in terms of consultation with works council and unions.

Pension entitlement for PSP's employees may be funded by way of a separate
pension fund, with an insurance company or by way of a book reserve system.

In case a book reserve system is used by Philips in a country, the pension
liabilities will transfer to ScanSoft and Philips shall include a provision in
the local balance sheet which is equal to the actuarial present value of pension
rights accrued up to the effective date as calculated under the relevant local
book reserve system concerned.

In case of a dedicated Philips pension fund, transferred employees will
either get a premium free policy or there will be a collective transfer of
liabilities and assets under the terms and rules set by the pertaining pension
fund.

F-69

424B1 152nd Page of 174 TOC 1st Previous Next ↓Bottom Just 152nd
FINANCIAL STATEMENTS OF
THE SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS
OF LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

F-70

424B1 153rd Page of 174 TOC 1st Previous Next ↓Bottom Just 153rd
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
ScanSoft, Inc.:

We have audited the accompanying statement of assets and liabilities of the
Speech and Language Technologies operations of Lernout & Hauspie Speech Products
N.V. (the "Business" as defined in Note 1) as of September 30, 2001 and the
related statement of revenue and direct operating expenses for the nine months
ended September 30, 2001 (herein referred to as the "financial statements").
These financial statements are the responsibility of the management of ScanSoft,
Inc. Our responsibility is to express an opinion on these financial statements
based on our audit.

We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

The accompanying financial statements were prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission as described in Note 1 and are not intended to be a complete
presentation of the Business' results of operations and financial position.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the assets and liabilities as of September 30, 2001
and the revenue and direct operating expenses (as described in Note 1 to the
financial statements) for the nine months ended September 30, 2001, in
conformity with accounting principles generally accepted in the United States of
America.

/s/ PricewaterhouseCoopers LLP

September 6, 2002
Boston, Massachusetts

F-71

424B1 154th Page of 174 TOC 1st Previous Next ↓Bottom Just 154th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 2001
(IN THOUSANDS)

[Download Table]

ASSETS
Accounts receivable, net of allowance for doubtful accounts
of $767................................................... $ 7,703
Inventory................................................... 138
Prepaid expenses and other current assets................... 126
Property and equipment, net................................. 4,160
Intangible assets, net of accumulated amortization of
$1,734.................................................... 8,448
-------
Total assets.............................................. $20,575
=======

LIABILITIES AND PARENT COMPANY INVESTMENT
Accounts payable............................................ 4,694
Accrued liabilities......................................... 4,383
-------
Total liabilities......................................... 9,077
Commitments and contingencies (Note 7)
Parent company investment................................... 11,498
-------
Total liabilities and parent company investment........... $20,575
=======

The accompanying notes are an integral part of these financial statements.
F-72

424B1 155th Page of 174 TOC 1st Previous Next ↓Bottom Just 155th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

STATEMENT OF REVENUE AND DIRECT OPERATING EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS)

[Download Table]

Revenue..................................................... $ 34,173
Direct operating expenses:
Cost of revenue........................................... 4,439
Cost of revenue from amortization of intangible assets.... 1,734
Research and development.................................. 28,440
Selling, general and administrative....................... 32,742
--------
Total direct operating expenses........................ 67,355
--------
Excess of direct operating expenses over revenue............ $(33,182)
========

The accompanying notes are an integral part of these financial statements.
F-73

424B1 156th Page of 174 TOC 1st Previous Next ↓Bottom Just 156th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

General. The accompanying financial statements have been prepared pursuant
to the transaction described below and present the assets and liabilities and
the revenue and direct operating expenses of the Speech and Language
Technologies operations of Lernout & Hauspie Speech Products N.V. ("L&H"),
hereinafter defined as the "Business" or "SLT." SLT was a provider of speech and
language software, which included the RealSpeak text-to-speech technology,
Dragon speech recognition software and other speech and voice-related
technologies aimed at the telecommunications, automotive and mobile device
markets. L&H did not maintain SLT as a separate business unit, but rather
operated the Business within Lernout & Hauspie Speech Products N.V. and several
of its subsidiaries, the most significant of which was L&H Holdings USA. In
November 2000, Lernout & Hauspie Speech Products N.V. and L&H Holdings USA, Inc.
filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court
for the District of Delaware. L&H NV also filed a bankruptcy proceeding in
Icper, Belgium. In order to facilitate the sale of its assets in connection with
the bankruptcy proceedings, L&H segregated the SLT operations into eight speech
and language technology asset groups.

On December 7, 2001, ScanSoft, Inc. ("ScanSoft") entered into an Asset
Purchase Agreement (the "Purchase Agreement") to acquire certain assets and
intellectual property and assume certain liabilities of the Speech and Language
Technologies operations of L&H. The acquisition was conducted in a closed
auction proceeding and approved by the United States bankruptcy court on
December 11, 2001. The acquisition was completed on December 12, 2001.

Pursuant to the Purchase Agreement, ScanSoft acquired three of the eight
asset groups of SLT: Dragon Naturally Speaking ("DNS"), Text to Speech ("TTS")
and Automated Speech Recognition ("ASR"), which represented the majority of the
revenue-generating assets of SLT. The net assets acquired by ScanSoft consisted
of (1) patents, trademarks, trade names and products associated with the
acquired speech and language technology assets of L&H; (2) customer contracts
and relationships and certain obligations associated with such contracts; (3)
rights to accounts receivable related to the customer contracts acquired; and
(4) certain inventory, fixed assets and other liabilities. ScanSoft also hired
223 employees of the research and development, sales and marketing and general
and administrative organizations of SLT. ScanSoft paid total consideration of
$41.3 million as follows: $10.0 million in cash, 7.4 million shares of ScanSoft
common stock valued at $27.8 million (based on the average of the closing share
price of the common stock 3 days before and after the proposed acquisition was
announced) and a 9% promissory note in the principal amount of $3.5 million to
be repaid in installments of $0.1 million of principal and interest quarterly
commencing on March 15, 2002. All remaining principal and interest on the note
is due and payable on December 15, 2004.

On August 13, 2002, the U.S. Bankruptcy Court for the District of Delaware
approved, without objection, ScanSoft's agreement with representatives of L&H
Holdings USA and Lernout & Hauspie Speech Products N.V. to repurchase shares of
ScanSoft common stock worth $7.0 million at a share price equal to the average
of the closing price for the 20 trading days beginning August 14, 2002, but no
less than $4.79 per share. In addition, ScanSoft agreed to issue up to 300,000
shares of common stock to the holders of approximately six million shares
remaining in the event that Scansoft does not offer the remaining shares in a
public offering by February 15, 2003, and 100,000 shares of common stock if
ScanSoft has not registered the remaining shares by February 15, 2003.

Basis of Presentation. As described above, L&H did not operate SLT as a
separate business unit, therefore, complete financial statements historically
were not prepared for SLT. The accompanying financial statements were derived
from the historical accounting records of L&H in order to present the statement
of assets and liabilities as of September 30, 2001, and the statement of revenue
and direct operating expenses for the nine months ended September 30, 2001, in
accordance with accounting
F-74

424B1 157th Page of 174 TOC 1st Previous Next ↓Bottom Just 157th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

principles generally accepted in the United States of America. As noted above,
the three asset groups acquired by ScanSoft represented the majority of the
revenue-generating assets of SLT. Accordingly, the statement of assets and
liabilities and the statement of revenue and direct operating expenses reflect
all of the eight technology asset groups. All other assets, liabilities,
revenues, and operating expenses of L&H were excluded from the financial
statements, as they were not directly attributable to SLT.

Direct operating expenses are comprised primarily of employee-related
expenses, including employee salaries and benefits, and other direct costs
related to the operations of the Business such as cost of revenue, advertising,
depreciation and amortization. Direct operating expenses also include other
operating expenses, including facilities and related costs, which were allocated
to the Business based on the number of employees dedicated to the Business.
Additionally, the Business relied on L&H for certain administrative, management
and other support services, and the related expenses were also allocated to the
Business based on the number of employees dedicated to the Business. Management
believes the method used to allocate the direct operating expenses and other
infrastructure and support costs is reasonable. L&H did not segregate indirect
corporate expenses and interest income (expense); accordingly these items are
not included in the financial statements of the Business. The statement of
assets and liabilities includes liabilities which existed at the time of
bankruptcy filing. No adjustment to reflect the ultimate settlement of these
liabilities subsequent to September 30, 2001 has been reflected in these
financial statements. The financial statements are therefore stated at
historical cost.

The financial statements were prepared to substantially comply with the
rules and regulations of the Securities and Exchange Commission for business
combinations and are not intended to be a complete presentation of the Business'
financial position, results of operations and cash flows. The historical net
assets and historical revenue and direct operating expenses of the Business
could differ from those that would have resulted had the Business operated
autonomously or as an entity independent of L&H. Furthermore, the financial
statements reflect all of the operations of the Business; however, as described
above, ScanSoft did not acquire all of the net assets of SLT, did not retain a
significant number of personnel directly related to historical operations of the
Business, and did not continue to operate the facilities previously used by the
Business. Consequently, the historical operating results may not be indicative
of the results of operations of the Business in the future.

As described above, L&H did not maintain SLT as a separate business unit.
More specifically, SLT was defined by L&H during 2001 in connection with
bankruptcy proceedings. Since L&H did not have a policy of allocating certain
assets and liabilities and income and expense balances to the Business, such
amounts, as described above, have not been included in the financial statements.
Consequently, a full balance sheet, statement of operations and stockholders'
equity are impractical to prepare. Furthermore, a statement of cash flows is not
presented because the Business did not maintain a cash balance and was dependent
upon L&H for financing the cash flows of the operations.

In accordance with Rule 3-06 of Regulation S-X, the statement of revenue
and direct operating expenses is presented for the nine months ended September
30, 2001 in satisfaction of the requirement for one year of audited financial
statements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION

Revenue was derived primarily from the sale of software products to
end-users through distribution partners and value added resellers (VARs),
royalty revenues from OEM partners, and license fees from direct sales of
products to end-users.

F-75

424B1 158th Page of 174 TOC 1st Previous Next ↓Bottom Just 158th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

SLT applied the provisions of Statement of Position 97-2 "Software Revenue
Recognition," as amended by Statement of Position 98-9 "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products. In addition, SLT applied
the provisions of Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements."

SLT sold software products to distributors and resellers who in turn sold
the products to retailers and VARs. Title and risk-of-loss passed to the
distributor upon shipment, at which time payment was generally due. Revenue from
sales of products to distributors and resellers was recognized (i) upon shipment
by the distributor or reseller to the VAR or (ii) upon shipment by the retailer
to end-users of the products. Agreements with distributors and resellers
provided for rights of return which, in the case of VARs, generally lapsed upon
shipment to the VARs, and, in the case of sales to retailers, upon shipment to
end-users. Provisions for product returns were recorded as a reduction of
revenue.

From late 2000 to mid-2001, SLT changed the distribution channel of its
retail products from traditional distributors and resellers to republishers.
Republishers had sole responsibility for the marketing, manufacturing and
distribution of SLT's products to retailers. Under the republishing
arrangements, SLT earned a royalty based on the sale price of its products by
republishers to retailers, as reported by republishers. Republishing
arrangements generated proportionately lower revenue than did traditional
distribution channels since the seller received a royalty in lieu of the full
sales price. Similarly, the direct costs, primarily manufacturing and marketing,
were proportionately lower under republisher agreements than under agreements
with traditional distributors and resellers.

SLT entered into royalty-bearing agreements with original equipment
manufacturers (OEMs) and recognized revenue for royalty fees based on actual
royalties earned and reported.

Revenue from the direct sales of licenses of SLT's software products to
end-users was recognized upon delivery, provided that no significant obligations
remained, evidence of the arrangement existed, the fees were fixed or
determinable, and collectibility was reasonably assured.

For arrangements with multiple elements (e.g., undelivered maintenance and
support bundled with perpetual licenses), SLT allocated revenue to the delivered
elements of the arrangement using the residual value method, deferring revenue
for undelivered elements based on evidence of the fair value of those
undelivered elements, which was specific to SLT. The vendor specific objective
evidence of fair values for the ongoing maintenance and support obligations was
based upon substantive renewal rates stated in the contractual arrangements.
Maintenance and support revenue, which was not significant to the results of
operations, was recognized ratably over the service period.

SLT also entered into fixed-fee contracts for software and related
services, which included significant customization or modification of the
software. As a result, SLT recognized revenue on the percentage-of-completion
basis of accounting. Under the percentage-of-completion basis of accounting,
revenue was recognized as the work progressed in amounts estimated to equal the
actual progress on the contract. In applying this method, SLT measured each
project's percentage-of-completion by the ratio of labor hours incurred to date
to the estimated total labor hours for the project. Losses on contracts were
recorded in the period they are determined, and the related obligations to
perform the remaining services were included in accrued liabilities. For
contracts in which SLT was unable to reasonably estimate the cost to complete
the contract, SLT recognized revenue upon completion of the contract.

INVENTORY

Inventory is stated at the lower of cost (determined on a first-in,
first-out basis) or market value. At September 30, 2001, inventory consisted
primarily of finished goods.
F-76

424B1 159th Page of 174 TOC 1st Previous Next ↓Bottom Just 159th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Major improvements are
capitalized, while expenditures for maintenance, repairs, and minor improvements
are charged to expense. When assets are retired or otherwise disposed of, the
assets and related accumulated depreciation and amortization are eliminated from
the accounts and any resulting gain or loss is reflected in results of
operations. Depreciation was computed using the straight-line method over the
estimated useful lives of the assets for computer equipment, software,
furniture, fixtures and office equipment. Leasehold improvements are depreciated
over the term of the lease.

INTANGIBLE ASSETS

Intangible assets represent the original fair value of intangible assets
resulting from prior business or asset acquisitions, adjusted for impairment
charges to reduce the carrying value to its fair value at the time of the
impairment charge. Intangible assets were amortized using the straight-line
method over their estimated useful lives of 5 years. Amortization expense
amounted to $1.7 million for the nine months ended September 30, 2001. This
amount is included in cost of revenue.

IMPAIRMENT OF LONG-LIVED ASSETS

The recoverability of long-lived assets is evaluated upon indication of
possible impairment by measuring the carrying value of the assets against the
related undiscounted future cash flows. When an evaluation indicates that the
future undiscounted cash flows are not sufficient to recover the carrying value
of the asset, the asset is adjusted to its estimated fair value by recording an
impairment charge based on the excess of the carrying value of the assets over
the discounted estimated cash flows.

RESEARCH AND DEVELOPMENT

Research and development costs were expensed as incurred.

FOREIGN CURRENCY TRANSLATION

The functional currencies for the Business were the U.S. Dollar and the
Euro as determined by the location of the operation. The financial information
recorded in the Euro was translated to U.S. dollars using the average exchange
rate for the nine months ended September 30, 2001. Translation gains and losses
were recorded as non-operating expense and therefore are not included in the
statement of revenues and direct operating expenses.

INCOME TAXES

No provision for income taxes was provided in the accompanying statement of
revenue and direct operating expenses because, on a separate return basis, the
business would have generated a taxable loss. No tax benefit resulting from such
taxable loss was recorded due to the uncertainty of realizing such tax benefit.

There are no net deferred tax assets reflected in the accompanying
statement of assets and liabilities because, on a separate return basis, a full
valuation allowance would have been recorded due to the uncertainty of
realization of the net assets.

F-77

424B1 160th Page of 174 TOC 1st Previous Next ↓Bottom Just 160th
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

CONCENTRATION OF CREDIT RISK

SLT sold its software products and services to channel partners or
customers located mainly in North America, Europe, and Asia-Pacific. SLT did not
require collateral from its customers. For the nine months ended September 30,
2001, no customer accounted for more than 10% of revenue. At September 30, 2001,
two customers accounted for 21% and 17% of net accounts receivable,
respectively.

USE OF ESTIMATES

3. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at September 30, 2001 (in
thousands):

[Download Table]

USEFUL LIVES
IN YEARS
------------

Computer equipment and software............................. 3 $ 19,108
Furniture, fixtures and office equipment.................... 5-7 5,633
Leasehold improvements...................................... 6 2,724
--------
27,465
Accumulated depreciation.................................... (23,305)
--------
$ 4,160
========

Depreciation expense associated with property and equipment was $5.1
million for the nine months ended September 30, 2001.

4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable at September 30, 2001 include $3.7 million of liabilities
that existed prior to the bankruptcy filings during 2000.

Accrued liabilities were comprised of the following at September 30, 2001
(in thousands):

[Download Table]

Accrued employee compensation and benefits.................. $2,546
Obligations to perform services under customer development
contracts................................................. 1,283
Accrued expenses............................................ 554
------
Total accrued liabilities.............................. $4,383
======

5. INTERCOMPANY COST ALLOCATIONS AND PARENT COMPANY INVESTMENT

Certain costs are allocated to the Business by the Parent, primarily
related to certain facilities, infrastructure and support services. The
estimated costs of such services have been allocated to the financial statements
of the Business based on employee headcount of the Business proportionate to the
headcount of the Parent. Management believes these allocations are reasonable.
See Note 1.

F-78

424B1 161st Page of 174 TOC 1st Previous Next ↓Bottom Just 161st
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The Business obtained financing for its day-to-day operations from L&H (the
"Parent"). Parent company investment represents these investments made by the
Parent. Interest expense associated with the Parent's general corporate debt has
not been included in the financial statements because amounts were neither
charged nor allocated to the Business.

6. EMPLOYEE BENEFIT PLANS

Employee benefit costs included in direct operating expenses comprise the
cost of medical, dental, life insurance and other benefit costs. For U.S.
employees, employee benefit costs included employer contributions to a
retirement savings plan under Section 401(k) of the Internal Revenue Service,
which covered substantially all U.S. employees who met minimum age and service
requirements. Employer contributions represented a match of 50% of contributions
made by employees through payroll deductions in amounts allowed up to 3% of an
employee's salary. The employer contribution was capped at 50% of the statutory
maximums. The 401(k) employer contribution associated with the SLT employees for
the nine months ended September 30, 2001 was approximately $150,000.

7. COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

Operating leases for facilities were entered into by L&H. The Business'
operations were conducted from several of these facilities which also supported
other operations of L&H. Rent expense allocated to the Business was
approximately $3.0 million for the nine months ended September 30, 2001.

COMMITMENTS AND CONTINGENCIES

L&H entered into arrangements with third-parties under which L&H granted
rights to the manufacturing, marketing and distribution of certain products of
the Business. Under certain of these agreements, L&H granted rights to future
products. As a result of the bankruptcy proceedings, and more specifically the
transfer to ScanSoft of the rights to the same products and technologies,
certain of these third parties claimed that L&H breached their respective
contracts. Subsequent to the acquisition of the Business by ScanSoft, L&H,
ScanSoft and certain of these third parties entered into settlement agreements
which required payments by each of the parties. The total amount due to the
third parties amounted to approximately $2.2 million, of which L&H was obligated
for approximately $0.7 million. No amounts have been recorded in the historical
financial statements of the Business at September 30, 2001 because the financial
obligation arose in connection with the acquisition by ScanSoft on December 12,
2001.

L&H established a Key Employee Retention Plan ("KERP") in order to retain
certain employees during 2001. Under the KERP, L&H was obligated to make
payments to employees, including SLT employees, only upon termination of
employment due to the acquisition by a third party of the assets of L&H. The
maximum KERP obligation related to SLT employees totaled $3.0 million at
September 30, 2001.

F-79

424B1 162nd Page of 174 TOC 1st Previous Next ↓Bottom Just 162nd
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

8. SEGMENT INFORMATION

SLT operated in one segment. The revenue and related cost of revenue SLT
attributed to geographic areas (based on the location in which the sale was
invoiced) was as follows for the nine months ended September 30, 2001 (in
thousands):

[Download Table]

NORTH
AMERICA EUROPE TOTAL
------- ------ -------

Revenue.................................................. $25,105 $9,068 $34,173
Cost of revenue.......................................... 3,315 1,124 4,439
Cost of revenue from amortization of intangible assets... -- 1,734 1,734
Property and equipment, net.............................. 3,135 1,025 4,160

9. RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141 ("SFAS 141"), Business Combinations and
No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets. SFAS 141 requires
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. SFAS 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets,
including how goodwill and other intangible assets should be accounted for after
they have been initially recognized. In addition, SFAS 142 includes provisions
for the reclassification of certain existing recognized intangible assets, such
as acquired workforce, into goodwill. SFAS 142 provides that goodwill and
intangible assets that have indefinite useful lives not be amortized but rather
be tested at least annually for impairment; intangible assets with finite useful
lives will continue to be amortized over their useful lives. SFAS 142 also
provides specific guidance for testing goodwill for impairment. The statement is
effective for acquisitions that are completed after June 30, 2002 and for
existing acquisitions on January 1, 2002. The statement would not have had a
significant impact on the Business' financial position or results of operations.

In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS
144"). SFAS 144 superseded SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of and provides a
single accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired. SFAS 144 is effective for financial statements issued for fiscal
years beginning after December 15, 2001. The statement would not have had a
significant impact on the Business' financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS No. 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for

F-80

424B1 163rd Page of 174 TOC 1st Previous Next ↓Bottom Just 163rd
SPEECH AND LANGUAGE TECHNOLOGIES OPERATIONS OF
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) ("EITF 94-3"). SFAS No.
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. EITF 94-3 allowed for an
exit cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002. The statement would not have had a significant impact on the Business'
financial position or results of operations.

F-81

424B1 164th Page of 174 TOC 1st Previous Next ↓Bottom Just 164th
SCANSOFT, INC.
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

F-82

424B1 165th Page of 174 TOC 1st Previous Next ↓Bottom Just 165th
SCANSOFT, INC.

UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

On October 7, 2002, ScanSoft, Inc. ("ScanSoft") entered into a definitive
agreement with Royal Philips Electronics ("Philips") to acquire the Philips
Speech Processing Telephony and Voice Control business units ("PSP") and related
intellectual property. On January 30, 2003, we completed the acquisition of the
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics, and related intellectual property on the terms set forth in the
purchase agreement dated October 7, 2002, as amended. As consideration for these
business units and intellectual property, 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.

On December 12, 2001, ScanSoft acquired substantially all of the speech and
language technologies operations ("SLT") of Lernout & Hauspie Speech Products
N.V. and certain of its affiliates ("L&H"). Consideration for the transaction
comprised $10 million in cash, a $3.5 million note due December 15, 2004 and 7.4
million shares of our common stock having a value of $27.8 million. The
operations acquired include text-to-speech, speech recognition and dictation,
and voice control technologies.

The unaudited pro forma financial information as of and for the nine months
ended September 30, 2002 gives effect to the acquisition of PSP as if ScanSoft
and PSP had been combined as of January 1, 2002 for statement of operations
purposes and as of September 30, 2002 for balance sheet purposes. The SLT
acquisition was consummated on December 12, 2001. Therefore, the balance sheet
impact of the acquisition is reflected in the historical balance sheet of
ScanSoft as of September 30, 2002.

The unaudited pro forma combined statement of operations for the year ended
December 31, 2001 gives effect to the acquisition by ScanSoft of SLT and the
proposed acquisition of PSP as if the acquisitions had occurred on January 1,
2001, combining the statement of operations of ScanSoft and the statement of
operations of PSP for the year ended December 31, 2001 and the statement of
revenues and direct operating expenses of SLT for the nine months ended
September 30, 2001 in satisfaction of one year of financial information in
accordance with Rule 3-06 of Regulation S-X.

The unaudited pro forma adjustments related to the acquisition of PSP are
based on estimates and assumptions that are preliminary and have been made
solely for purposes of developing such pro forma information. The estimated pro
forma adjustments arising from the acquisition of PSP are derived from the
estimates of the price to be paid for the acquisition and the estimated fair
values of the assets acquired and liabilities assumed. The final determination
of purchase price, fair value of the net assets acquired and resulting goodwill
may differ significantly from that reflected in the pro forma statement of
operations and balance sheet. No significant transactions occurred between
ScanSoft and PSP or SLT and PSP for the year ended December 31, 2001 or for the
nine months ended September 30, 2002 and no amounts were due to or from ScanSoft
or PSP as of September 30, 2002.

The historical PSP financial information has been derived from the audited
financial statements of PSP included in this Registration Statement and have
been translated from euros to US dollars using the exchange rates in effect at
the end of the period for the balance sheet and using average exchange rates for
the respective periods for the statements of operations.

The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the operating results or financial position
that would have occurred if the transactions had been consummated as of January
1, 2001 or January 1, 2002, as applicable, for the statements of operations or
September 30, 2002, for the balance sheet, nor is it necessarily indicative of
future operating results or financial position. The unaudited pro forma combined
financial information should be read in conjunction with the historical
financial statements of ScanSoft, PSP, and SLT and related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" of ScanSoft included elsewhere in this Registration Statement.

F-83

424B1 166th Page of 174 TOC 1st Previous Next ↓Bottom Just 166th
SCANSOFT, INC.

UNAUDITED PRO FORMA COMBINED BALANCE SHEET
SEPTEMBER 30, 2002

[Enlarge/Download Table]

PRO FORMA PRO FORMA
SCANSOFT PSP ADJUSTMENTS COMBINED
---------- ------- ------------ ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

ASSETS
Current assets:
Cash and cash equivalents................... $ 14,382 $ 12 $(3,412)(1)(2) $ 10,982
Accounts receivable, net.................... 15,868 4,462 20,330
Receivables from related parties............ 1,238 705 (705)(2) 1,238
Inventory................................... 1,562 753 2,315
Prepaid expenses and other current assets... 2,853 602 3,455
--------- ------ ------- ---------
Total current assets..................... 35,903 6,534 (4,117) 38,320
Goodwill...................................... 63,308 29,560(1) 92,868
Other intangible assets, net.................. 36,035 132 7,728(1)(2) 43,895
Property and equipment, net................... 2,933 378 3,311
Other assets.................................. 1,091 1,091
--------- ------ ------- ---------
Total Assets.................................. $ 139,270 $7,044 $33,171 $ 179,485
========= ====== ======= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ 5,541 655 6,196
Accrued expenses............................ 11,695 2,000(1) 13,695
Deferred revenue............................ 955 1,112 2,067
Note payable................................ 227 227
Payables to related parties................. -- 1,971 (1,971)(1)(2) --
Other current liabilities................... 1,720 2,305 914(1)(2) 4,939
--------- ------ ------- ---------
Total current liabilities................ 20,138 6,043 943 27,124
Deferred revenue.............................. 278 278
Convertible debt.............................. -- 27,500(1) 27,500
Long-term note payable, net of current
portion..................................... 3,101 5,400(1) 8,501
Other liabilities............................. 819 329 1,148
--------- ------ ------- ---------
Total liabilities........................ 24,336 6,372 33,843 64,551
--------- ------ ------- ---------
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; 65,334,366 shares
issued and 63,216,988 shares outstanding,
respectively............................. 65 65
Additional paid-in capital.................. 269,822 269,822
Treasury stock, at cost; 2,117,378 shares... (8,031) (8,031)
Deferred compensation....................... (199) (199)
Accumulated other comprehensive income...... 12 12
Net Investment of the Philips Group......... -- 672 (672)(2) --
Accumulated deficit......................... (151,366) (151,366)
--------- ------ ------- ---------
Total stockholders' equity............... 114,934 672 (672) 114,934
--------- ------ ------- ---------
Total Liabilities and Stockholders' Equity.... $ 139,270 $7,044 $33,171 $ 179,485
========= ====== ======= =========

See accompanying Notes to Unaudited Pro Forma Combined Financial Statements.
F-84

424B1 167th Page of 174 TOC 1st Previous Next ↓Bottom Just 167th
SCANSOFT, INC.

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001

[Enlarge/Download Table]

PRO FORMA PRO FORMA
ADJUSTMENTS ADJUSTMENTS PRO FORMA
SCANSOFT SLT PSP SLT PSP COMBINED
-------- -------- -------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Revenue, third
parties............... $ 56,647 $ 34,173 $ 14,165 $(3,329)(12) $ -- $101,656
Revenue, related
party................. 7,208 -- 2,591 -- -- 9,799
-------- -------- -------- ------- ------- --------
Total revenue......... 63,855 34,173 16,756 (3,329) -- 111,455
-------- -------- -------- ------- ------- --------
Costs and expenses:
Cost of revenue....... 12,849 4,439 2,948 (41)(4) 20,195
Cost of revenue from
amortization of
intangible
assets............. 14,192 1,734 -- 100(7) 630(3) 16,656
Research and
development........ 13,968 28,440 12,114 -- 54,522
Selling general and
administrative..... 26,449 32,742 16,982 76,173
Amortization of
goodwill and other
intangible
assets............. 13,328 -- -- 889(3) 14,217
-------- -------- -------- ------- ------- --------
Total costs and
expenses.............. 80,786 67,355 32,044 100 1,478 181,763
-------- -------- -------- ------- ------- --------
Loss from operations.... (16,931) (33,182) (15,288) (3,429) (1,478) (70,308)
Other (expense) income,
net................... (263) -- 2 (315)(9) (226)(5)(6) (802)
-------- -------- -------- ------- ------- --------
Loss before income
taxes................. (17,194) (33,182) (15,286) (3,744) (1,704) (71,110)
Provision for (benefit
from) income taxes.... (317) -- (1,223) -- 1,223(8) (317)
-------- -------- -------- ------- ------- --------
Net loss................ $(16,877) $(33,182) $(14,063) $(3,744) $(2,927) $(70,793)
======== ======== ======== ======= ======= ========
Pro forma net loss per
common share(10):
Basic and diluted....... $ (0.34) $ (1.25)
======== ========
Weighted average common
shares used in pro
forma net loss per
share calculation(10):
Basic and diluted....... 49,693 6,989(11) 56,682

See accompanying Notes to Unaudited Pro Forma Combined Financial Statements.
F-85

424B1 168th Page of 174 TOC 1st Previous Next ↓Bottom Just 168th
SCANSOFT, INC.

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002

[Enlarge/Download Table]

PRO FORMA PRO FORMA
SCANSOFT PSP ADJUSTMENTS COMBINED
-------- ------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Revenue, third parties.......................... $74,598 $11,633 $ -- $86,231
Revenue, related party.......................... 3,586 361 -- 3,947
------- ------- ------- -------
Total revenue................................. 78,184 11,994 -- 90,178
------- ------- ------- -------
Costs and expenses:
Cost of revenue............................... 12,937 1,605 (25)(4) 14,517
Cost of revenue from amortization of
intangible assets.......................... 7,494 -- 467(3) 7,961
Research and development...................... 21,310 7,300 -- 28,610
Selling general and administrative............ 32,051 10,676 42,727
Amortization of goodwill and other intangible
assets..................................... 1,446 -- 667(3) 2,113
Restructuring and other charges............... 1,041 1,041
------- ------- ------- -------
Total costs and expenses........................ 76,279 19,581 1,109 96,969
------- ------- ------- -------
Income (loss) from operations................... 1,905 (7,587) (1,109) (6,791)
Other (expense) income, net..................... (178) 6 (180)(5)(6) (352)
------- ------- ------- -------
Income (loss) before income taxes............... 1,727 (7,581) (1,289) (7,143)
Provision for (benefit from) income taxes....... (166) (227) 227(8) (166)
------- ------- ------- -------
Net income (loss)............................... $ 1,893 $(7,354) $(1,516) $(6,977)
======= ======= ======= =======
Pro forma net loss per common share(10):
Basic......................................... $ 0.03 $ (0.11)
======= =======
Diluted....................................... $ 0.03 $ (0.11)
======= =======
Shares used in pro forma net loss per share
calculation(10):
Basic......................................... 67,116 63,554
Diluted....................................... 72,451 63,554

See accompanying Notes to Unaudited Pro Forma Combined Financial Statements.
F-86

424B1 169th Page of 174 TOC 1st Previous Next ↓Bottom Just 169th
SCANSOFT, INC.

NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS

1. ACQUISITIONS

On December 7, 2001, ScanSoft entered into an Asset Purchase Agreement (the
"Purchase Agreement") to acquire certain assets and intellectual property and
assume certain liabilities of L&H. The assets were purchased and liabilities
assumed in a closed auction proceeding. The transaction was approved by United
States bankruptcy court on December 11, 2001. The transaction was completed on
December 12, 2001, and ScanSoft's results of operations include the activities
related to the acquisition since that date.

Pursuant to the Purchase Agreement, ScanSoft acquired patents, trademarks,
trade names, products and customer contracts associated with certain of the
speech and language technology assets of L&H. In addition, ScanSoft obtained
rights to accounts receivable related to the customer contracts acquired and
certain fixed assets. ScanSoft also hired 223 of the approximately 500 remaining
employees from L&H. Scansoft did not acquire any significant property and
equipment or assume any leases for property and equipment or facilities.
ScanSoft paid $41.3 million in total consideration to the creditors as follows:
$10.0 million in cash. 7.4 million shares of ScanSoft's common stock valued at
$27.8 million (based on the average of the closing share price of our stock 3
days before and after the proposed acquisition was announced), and a 9%
promissory note in the principal amount of $3.5 million, to be repaid quarterly
in installments of $0.1 million of principal and interest commencing on March
15, 2002, for a total of eleven payments. All remaining principal and interest
on the note is due and payable on December 15, 2004. ScanSoft incurred
approximately $1.0 million of costs related to the acquisition.

On August 13, 2002, the U.S. Bankruptcy Court for the District of Delaware
approved, without objection, ScanSoft's agreement with representatives of L&H
Holdings USA. and Lernout & Hauspie Speech Products N.V. to repurchase shares of
ScanSoft common stock worth $7.0 million at a share price equal to the average
of the closing price for the 20 trading days beginning August 14, 2002, but no
less than $4.79 per share. In addition, ScanSoft agreed to issue 150,000 shares
of common stock to the holders of approximately six million shares remaining in
the event ScanSoft does not offer the remaining shares in a public offering by
December 15, 2002. ScanSoft further agreed to issue an additional 150,000 shares
of common stock to the holders of approximately six million shares remaining in
the event ScanSoft does not offer the remaining shares in a public offering by
February 15, 2003, and 100,000 shares of common stock if ScanSoft has not
registered the remaining shares by February 15, 2003. Additionally, if the
consummation of this offering does not occur by January 1, 2003, the outstanding
principal and interest under the $3.5 million promissory note that ScanSoft
issued in connection with the acquisition of the L&H operations would become
immediately due and payable.

F-87

424B1 170th Page of 174 TOC 1st Previous Next ↓Bottom Just 170th
SCANSOFT, INC.

NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)

2. PRO FORMA ADJUSTMENTS

Pro forma adjustments reflect only those adjustments which are factually
determinable and, with respect to the PSP acquisition, do not include the impact
of contingencies which will not be known until the later of the closing of the
transaction or the resolution of the contingency. Pro forma adjustments include
the following:

(1) Adjustments to record the purchase accounting for the assets
acquired and the liabilities assumed of PSP, subject to adjustment pending
the completion of a post-closing review of the purchased net assets and
resolution of certain contingencies. The pro forma information reflects the
payment of $3.4 million in cash at the exchange rate on January 30, 2003 of
1.00 euro equaling $1.08, the issuance of a $5.0 million euro note due
December 31, 2003 and bearing 5.0% interest per annum and the issuance of a
$27.5 million three-year, zero-interest debenture, convertible at any time
into shares of our common stock at $6.00 per share. ScanSoft also has
accounted for $2.0 million for anticipated transaction fees, which include
legal, accounting, due diligence, tax structuring and filing fees. The fair
value of convertible debenture was determined to be $27.5 million based on
the present value of the expected cash outflows using ScanSoft's
incremental borrowing rate and the results of a Black-Scholes option
pricing calculation for the value of the conversion feature, using a fair
value of ScanSoft common stock of $3.50 per share, the closing price of
ScanSoft's common stock just prior to the parties entering into the
acquisition agreement.

Deferred revenue is comprised of (i) progress payments made by
customers under contracts for software licenses and services which
represent significant customization or modification of the software, (ii)
advance payments for services and (iii) up front payments for annual
software maintenance agreements. ScanSoft will assume legal obligations
under such contracts and will record the fair value of these obligations in
its final purchase accounting. The fair value of deferred revenue may
differ from the book value, however, our purchase price allocation is
preliminary because additional information is required to accurately
determine the fair value of the legal obligation that we assumed, certain
of which was not available at closing. The pro forma adjustments do not
include an adjustment to record the fair value of deferred revenue because
there is not yet sufficient information to make a factually supportable pro
forma adjustment.

Under the terms of the purchase agreement, the purchase price is
subject to adjustment based on a comparison of net assets at the closing
date to the net assets of PSP set forth in the agreement. Also, as a result
of the legal requirements related to labor matters in certain countries in
which PSP operates, primarily Germany, severance costs associated with the
restructuring actions described below are anticipated. ScanSoft will assume
the legal obligations of Philips with respect to severance benefits of the
PSP employees. Philips will reimburse ScanSoft for the costs associated
with restructuring actions related to German employees up to 5.0 million
euro through December 31, 2003. At the closing date, or as soon as
practicable thereafter, ScanSoft will record a liability for restructuring
costs and a related receivable for amounts to be reimbursed by Philips. To
the extent that the total costs exceed 5.0 million euro as of or at any
time prior to December 31, 2003, Philips will reimburse ScanSoft for
one-third of the excess costs and ScanSoft will be responsible for the
remaining two-thirds of any excess costs. The adjustment for any excess
costs will be recorded as additional purchase consideration and recorded as
goodwill.

The acquisition of PSP by ScanSoft will give rise to the elimination
of certain PSP personnel and excess facilities. ScanSoft anticipates
headcount reductions will occur across all functional areas of the combined
company. The total costs associated with the anticipated restructuring
actions will be dependent upon the outcome of required negotiations with
local labor councils, primarily in Germany. ScanSoft currently anticipates
that the restructuring activities will result in severance and
restructuring
F-88

424B1 171st Page of 174 TOC 1st Previous Next ↓Bottom Just 171st
SCANSOFT, INC.

NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)

costs ranging from $2.8 million to $3.3 million. Of this amount,
approximately $1.8 million to $2.3 million will be reimbursed by Philips.
The remaining amounts will be recorded as additional purchase price in
accordance with Emerging Issue Task Force No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination." Had these
actions taken place on January 1, 2002 they would have resulted in
approximately $4.8 million of reduced expenses for the nine months ended
September 30, 2002.

ScanSoft believes these planned restructuring actions are an integral
component of the acquisition plan to enable the benefits of the combined
companies to be optimized and the benefits of the acquisition to be
realized. ScanSoft expects to complete these restructuring efforts within
one year of the closing.

A summary of the preliminary purchase price allocation is as follows
(in thousands):

[Download Table]

Estimated consideration:
Cash................................................... $ 4,500
Note payable........................................... 5,400
Convertible debenture.................................. 27,500
Transaction costs...................................... 2,000
-------
Total estimated purchase consideration............... $39,400
=======
Preliminary allocation of the purchase consideration:
Net tangible assets acquired........................... $ 1,980
Identifiable intangible assets......................... 7,860
Goodwill............................................... 29,560
-------
$39,400
=======

ScanSoft believes that the $7.9 million of identifiable intangible
assets will be allocated to patents and core technology and completed
technology in the amount of $6.1 million and the remaining $1.8 million to
customer relationships and other contractual agreements. The $4.5 million
in cash is payable as follows: $3.4 million upon closing of the acquisition
and $1.1 million no later than December 31, 2003.

(2) Adjustments to eliminate historical assets and liabilities of PSP
that will not be acquired or assumed by ScanSoft including the $12,000 of
cash, $0.7 million of amounts due from Philips, $0.1 million of purchased
software, $2.0 million of payables to Philips, $0.2 million of other
liabilities and $0.7 million of net investment of the Philips Group which
will not be acquired or assumed by ScanSoft.

(3) Adjustment to record amortization expense for the identifiable
intangible assets. Finalization of the allocation of the purchase price to
tangible and identifiable intangible assets acquired and liabilities
assumed is preliminary pending completion of the transaction and collection
of data to evaluate estimates of future revenues and earnings to determine
a discounted cash flow valuation of certain intangibles that meet the
separate recognition criteria of SFAS No. 141. ScanSoft expects this
process and subsequent allocation of purchase price to be complete within
90 days of the closing of the transaction.

ScanSoft's preliminary assessment is that the weighted average useful
life of the patents and core technology and completed technology will be
approximately 10 years and other acquired identifiable

F-89

424B1 172nd Page of 174 TOC 1st Previous Next ↓Bottom Just 172nd
SCANSOFT, INC.

NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)

intangible assets will be approximately 2 years. The pro forma adjustments
for amortization are based on the weighted average useful life using the
straight-line method. A change in the allocation between patents and core
technology and completed technology and goodwill of $1,000,000 would result
in a change in pro forma annual amortization expense of approximately $0.1
million. A change in the allocation between the other acquired identifiable
intangible assets and goodwill of $1,000,000 would result in a change in
pro forma annual amortization of expense of approximately $0.5 million. An
increase in the weighted average useful life of the patents and core
technology and completed from ten years to eleven years would result in a
decrease in the pro forma amortization expense of less of than $0.1 million
for both the year ended December 31, 2001 and the nine months ended
September 30, 2002. A decrease in the weighted average useful life of the
patents, core technology and completed from ten years to nine years would
result in an immaterial decrease in the pro forma amortization expense of
less of than $0.1 million for both the year ended December 31, 2001 and the
nine months ended September 30, 2002. An increase in the weighted average
useful life of the other acquired identifiable intangible assets from two
years to three years would result in a change in pro forma annual
amortization expense of approximately $0.3 million and $0.2 million for the
year ended December 31, 2001 and the nine months ended September 30, 2002.

(4) Adjustment to eliminate amortization expense related to intangible
assets of PSP existing prior to the proposed acquisition which will not be
acquired by ScanSoft. Amortization expense of $41,000 and $25,000 was
eliminated for the year ended December 31, 2001 and the nine months ended
September 30, 2002, respectively.

(5) Adjustment to record interest expense on the 5.0 million euro
promissory note to be issued as partial purchase consideration for the
acquisition, bearing interest at five percent per year, as if the
consideration was issued on January 1, 2001. Interest expense for the year
ended December 31, 2001 and for the nine months ended September 30, 2002
would have been $224,000 and $174,000, respectively.

(6) Adjustment to eliminate interest recorded on intercompany balances
between PSP and Philips. Interest income adjusted totaled $2 thousand and
$6 thousand for the year ended December 31, 2001 and for the nine months
ended September 30, 2002, respectively.

(7) Adjustment to eliminate amortization expense included in the
historical financial statements of SLT of $1.7 million and to record the
amortization of the fair value of other intangible assets recorded in the
acquisition as if the acquisition had occurred on January 1, 2001.
Intangible assets recorded in connection with the SLT acquisition included
$17.9 million of patents and core technology, $3.1 million of trademarks
and tradenames and $21.4 million of goodwill. In accordance with SFAS No.
142, no goodwill amortization is reflected for ScanSoft's goodwill
resulting from the acquisition of SLT. Other intangible assets are
amortized using the straight-line method over their estimated useful lives
of ten years for patents and core technology and twelve years for
trademarks and tradenames.

(8) Adjustment to eliminate income tax benefits recorded by PSP in its
historical statements of operations which would not have been realized by
ScanSoft had the acquisition occurred on January 1, 2001.

(9) Adjustment to record additional interest expense related to the
note payable issued in partial consideration for the SLT acquisition as if
the acquisition had occurred on January 1, 2001. The interest rate on the
note is 9%. The outstanding principal balance is assumed to be the original
principal balance of $3.5 million based on the payment schedule included in
the note agreement. The accompanying unaudited pro forma combined statement
of operations does not assume any permitted prepayments of principal.

(10) The pro forma net loss per share and the shares used in pro
forma net loss per share do not include the effects of the assumed
conversion to common stock of the convertible debenture to be issued to
F-90

424B1 173rd Page of 174 TOC 1st Previous Next ↓Bottom Just 173rd
SCANSOFT, INC.

NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)

Philips as partial purchase consideration for the PSP acquisition because
the impact would be antidilutive. The total shares of common stock to be
issued upon conversion of the debenture would be 4,583,333.

(11) Adjustment to reflect the 7.4 million shares of common stock
issued to L&H in connection with the SLT acquisition as if the acquisition
had occurred on January 1, 2001.

(12) Adjustment to eliminate historical SLT revenues associated with
the five asset group ScanSoft did not acquire. No pro forma adjustments
have been made to the operating expenses of SLT because it is impracticable
to determine the amounts with individual asset groups of SLT.

F-91

424B1 Last Page of 174 TOC 1st Previous Next ↓Bottom Just 174th
[PROSPECTUS FEBRUARY 10, 2003 LOGO]

[ScanSoft Logo]

7,184,406 Shares

Common Stock

Thomas Weisel Partners LLC
Adams, Harkness & Hill, Inc.
Investec Inc.

--------------------------------------------------------------------------------

Neither we nor any of the underwriters have authorized anyone to provide
information different from that contained in this prospectus. When you make a
decision about whether to invest in our common stock, you should not rely upon
any information other than the information in this prospectus. Neither the
delivery of this prospectus nor the sale of our common stock means that
information contained in this prospectus is correct after the date of this
prospectus. This prospectus is not an offer to sell or solicitation of an offer
to buy these shares of common stock in any circumstances under which the offer
or solicitation is unlawful.

424B1	1st Page of 174	TOC	↑Top	Previous	Next	↓Bottom	Just 1st

424B1	2nd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 2nd

424B1	3rd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 3rd

424B1	4th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 4th

424B1	5th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 5th

424B1	6th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 6th

424B1	7th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 7th

424B1	8th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 8th

424B1	9th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 9th

424B1	10th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 10th

424B1	11th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 11th

424B1	12th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 12th

424B1	13th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 13th

424B1	14th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 14th

424B1	15th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 15th

424B1	16th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 16th

424B1	17th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 17th

424B1	18th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 18th

424B1	19th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 19th

424B1	20th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 20th

424B1	21st Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 21st

424B1	22nd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 22nd

424B1	23rd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 23rd

424B1	24th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 24th

424B1	25th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 25th

424B1	26th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 26th

424B1	27th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 27th

424B1	28th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 28th

424B1	29th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 29th

424B1	30th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 30th

424B1	31st Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 31st

424B1	32nd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 32nd

424B1	33rd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 33rd

424B1	34th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 34th

424B1	35th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 35th

424B1	36th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 36th

424B1	37th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 37th

424B1	38th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 38th

424B1	39th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 39th

424B1	40th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 40th

424B1	41st Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 41st

424B1	42nd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 42nd

424B1	43rd Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 43rd

424B1	44th Page of 174	TOC	1st	Previous	Next	↓Bottom	Just 44th

Dates Referenced Herein and Documents Incorporated by Reference

		Referenced-On Page
This ‘424B1’ Filing	Date	First	Last	Other Filings

	12/15/04	90	169	4
	4/17/04	55	73
	1/30/04	76
	12/31/03	4	171	10-K
	3/1/03	73
	2/28/03	56		SC 13G/A
	2/15/03	34	169
	2/14/03	79		8-K
Filed on:	2/11/03
	2/10/03	1	174	S-1/A
	1/30/03	4	170	8-K, 8-K/A
	1/3/03	4	128
	1/1/03	34	169
	12/31/02	4	163	10-K
	12/18/02	4	71
	12/15/02	34	169
	11/27/02	10	55
	11/25/02	39
	11/15/02	131
	10/31/02	4	129
	10/21/02	128		S-1
	10/16/02	68
	10/15/02	68
	10/7/02	4	169	8-K
	9/30/02	3	172	10-Q
	9/29/02	82	150
	9/6/02	153
	8/31/02	56
	8/22/02	98
	8/14/02	89	169	10-Q, 10-Q/A
	8/13/02	156	169
	7/31/02	125
	7/1/02	10	151
	6/30/02	3	162	10-Q
	6/27/02	54
	6/14/02	60	66	DEF 14A
	5/15/02	140		10-Q
	5/6/02	51
	5/1/02	50
	4/12/02	128
	4/5/02	60	66
	4/1/02	120		10-K
	3/31/02	25	121	10-Q, 10-Q/A
	3/21/02	71	128
	3/15/02	90	169
	3/13/02	106	126
	3/5/02	84	126
	3/2/02	70
	2/22/02	125
	2/12/02	112
	2/11/02	84	114
	1/1/02	21	171
	12/31/01	8	172	10-K
	12/27/01	89	120	8-K
	12/21/01	98		3, SC 13G
	12/15/01	40	162
	12/12/01	4	169	8-K, 8-K/A
	12/11/01	90	169	3
	12/7/01	89	169
	9/30/01	20	165	10-Q
	9/19/01	10	101
	8/16/01	10	101
	6/30/01	25	162	10-Q
	6/27/01	54	60	DEF 14A
	6/14/01	70
	1/23/01	54	60
	1/2/01	54
	1/1/01	165	173
	12/31/00	20	134	10-K405, 10-K405/A
	8/21/00	52	55
	6/30/00	109		10-Q
	4/27/00	58
	3/14/00	97
	3/13/00	20	106	8-K
	12/31/99	20	112	10-K405
	12/17/99	53
	9/30/99	70	71	10-Q
	9/13/99	71	112
	6/30/99	20	108	10-Q, 8-K
	6/29/99	100		DEF 14A
	3/31/99	33		10-Q
	3/12/99	64		S-8, SC 13D
	3/3/99	17
	3/2/99	4	107	8-K
	3/1/99	52
	1/6/99	4	112	8-K
	1/1/99	109
	12/31/98	20	99
	6/29/98	70	71
	3/25/98	70	71
	12/31/97	20
	1/1/97	62
	10/23/96	76
	12/11/95	17
				List all Filings

↑Top

Filing Submission 0000950135-03-000866 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

Nuance Communications, Inc. – ‘424B1’ on 2/11/03

On: Tuesday, 2/11/03, at 8:08am ET · Accession #: 950135-3-866 · File #: 333-100647

Prospectus — Rule 424(b)(1)Filing Table of Contents

Document Table of Contents

Dates Referenced Herein and Documents Incorporated by Reference

Prospectus — Rule 424(b)(1)
Filing Table of Contents