SCANSOFT INC, 10-Q, 2000-11-13

SCANSOFT INC
10-Q, 2000-11-13
COMPUTER PERIPHERAL EQUIPMENT, NEC

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<PAGE> 1

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE PERIOD ENDED SEPTEMBER 30, 2000

[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM __________ TO __________

COMMISSION FILE NUMBER 0-27038

SCANSOFT, INC.
(Exact Name of Registrant as Specified in its Charter)

DELAWARE 94-3156479
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)

9 CENTENNIAL DRIVE
PEABODY, MA 01960
(Address of Principal Executive Office)

(978) 977-2000
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No [ ]

45,980,848 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of October 31, 2000

<PAGE> 2

SCANSOFT, INC.

FORM 10-Q
NINE MONTHS ENDED SEPTEMBER 30, 2000

INDEX

PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)

a) Consolidated Balance Sheets at September 30, 2000 and
December 31, 1999....................................... 3

b) Consolidated Statements of Operations for the three and
nine months ended September 30, 2000 and
September 30, 1999...................................... 4

c) Consolidated Statements of Cash Flows for the nine months
ended September 30, 2000 and September 30, 1999......... 5

d) Notes to Consolidated Financial Statements................ 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................... 11

PART II: OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders.......... 20

Item 6. Exhibits and Reports on Form 8-K............................. 20

Signatures........................................................... 21

2
<PAGE> 3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
UNAUDITED

SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>

ASSETS
Current Assets:
Cash and cash equivalents ......................... $ 4,908 $ 5,162
Short-term investments ............................ 62 62
Accounts receivable, less allowances
of $6,812 and $3,690, respectively .............. 4,543 7,713
Inventory ......................................... 781 780
Deferred tax assets ............................... 3,650 --
Prepaid expenses and other current assets ......... 2,035 1,372
------------- -------------
Total current assets ........................... 15,979 15,089

Goodwill and other intangible assets, net .............. 99,485 12,987
Property and equipment, net ............................ 3,698 1,546
Other assets ........................................... 1,015 360
------------- -------------
TOTAL ASSETS ........................................... $ 120,177 29,982
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short term bank borrowings ........................ $ 4,300 $ --
Note payable ...................................... -- 1,600
Accounts payable .................................. 6,763 2,226
Accrued sales and marketing expenses .............. 1,574 1,425
Deferred revenue .................................. 1,030 964
Other current liabilities ......................... 6,752 1,843
------------- -------------
Total current liabilities ...................... 20,419 8,058
------------- -------------
Deferred revenue long-term ............................. 2,557 --
------------- -------------
Deferred tax liabilities ............................... 3,650 --
------------- -------------
Stockholders' equity:
Series B convertible preferred stock,
15,000,000 shares authorized;
3,562,238 issued and outstanding;
liquidation value of $4,631 ..................... 4,631 4,631
Common stock, $0.001 par value;
140,000,000 shares authorized;
45,979,398 and 26,690,027 shares
issued and outstanding, respectively ............ 46 27
Additional paid in capital ........................ 219,207 100,397
Accumulated deficit ............................... (130,172) (83,131)
Accumulated other comprehensive loss .............. (161) --
------------- -------------
Total stockholders' equity ..................... 93,551 21,924
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............. $ 120,177 $ 29,982
============= =============
</TABLE>

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

3
<PAGE> 4

SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----

Revenue ............................................. $ 13,638 $ 8,210 $ 35,028 $ 22,986

Costs and expenses:
Cost of revenue ................................ 2,962 1,994 9,487 5,427
Research and development ....................... 3,830 1,717 11,884 5,140
Selling, general and administrative ............ 6,842 3,234 21,051 10,288
Amortization of intangible assets .............. 6,787 655 15,799 1,288
Restructuring and other charges ................ -- -- 4,956 346
Gain on sale of hardware business, net ......... -- -- -- (882)
Acquired in-process research and development ... -- -- 18,291 3,944
-------- -------- -------- --------

Total costs and expenses ............................ 20,421 7,600 81,468 25,551
-------- -------- -------- --------

Income (loss) from operations ....................... (6,783) 610 (46,440) (2,565)

Other income (expense), net ......................... (257) 62 (257) 136
-------- -------- -------- --------

Income (loss) before income taxes ................... (7,040) 672 (46,697) (2,429)

Provision for income taxes .......................... 36 200 344 300
-------- -------- -------- --------

Net income (loss) ................................... $ (7,076) $ 472 $(47,041) $ (2,729)
======== ======== ======== ========

Net income (loss) per share: basic .................. $ (0.15) $ 0.02 $ (1.15) $ (0.11)
======== ======== ======== ========

Net income (loss) per share: diluted ................ $ (0.15) $ 0.01 $ (1.15) $ (0.11)
======== ======== ======== ========

Weighted average common shares: basic ............... 45,963 26,472 40,800 25,220
======== ======== ======== ========

Weighted average common and common equivalent shares:
diluted ........................................ 45,963 31,937 40,800 25,220
======== ======== ======== ========
</TABLE>

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

4
<PAGE> 5

SCANSOFT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED

NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
---- ----
<S> <C> <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................. $(47,041) $ (2,729)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ....................................... 968 239
Provision for accounts receivable allowances ........................ (3,467) 2,024
Amortization of goodwill and other intangible assets ................ 15,799 1,288
Provision for impairment of intangible assets ....................... 3,490 --
Net gain on sale of hardware business ............................... -- (882)
Write off of acquired in-process research and development ........... 18,291 3,944
Changes in assets and liabilities, net of effects from
acquisitions of Caere, ScanSoft, and sale of hardware assets:
Accounts receivable ............................................. 8,075 (8,037)
Inventory ....................................................... 283 (122)
Prepaid expenses and other assets ............................... (493) 73
Accounts payable and accrued expenses, accrued marketing,
deferred revenue and other current liabilities................. (588) 1,883
-------- --------

Net cash used in operating activities .................................... (4,683) (2,319)
-------- --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired in connection with Caere acquisition .................. 1,419 --
Capital expenditures for property and equipment ..................... (256) (186)
Net sales of short-term investments ................................. -- 397
Proceeds from sale of hardware business ............................. -- 6,782
Cash acquired in connection with ScanSoft acquisition ............... -- 1,211
Cash used for Metacreations acquisition ............................. -- (1,669)
-------- --------

Net cash provided by investing activities ................................ 1,163 6,535
-------- --------

CASH FLOWS FROM FINANCING ACTIVITIES:
Short term bank borrowings, net ..................................... 4,300 (6,000)
Payment of note payable ............................................. (1,600) --
Proceeds from the issuance of common stock, net ..................... 655 118
Repurchase of common stock .......................................... -- (684)
-------- --------

Net cash provided by (used in) financing activities ...................... 3,355 (6,566)
-------- --------

Effects of exchange rate changes on cash and cash equivalents ............ (89) --
-------- --------

Net decrease in cash and cash equivalents ................................ (254) (2,350)
Cash and cash equivalents at beginning of period ......................... 5,162 7,659
-------- --------
Cash and cash equivalents at end of period ............................... $ 4,908 $ 5,309
======== ========
</TABLE>

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

5
<PAGE> 6

SCANSOFT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

BASIS OF PRESENTATION:

Prior to 1999, the results of the Company represented the activity of
Visioneer, Inc., which marketed and sold hardware and software. On January 6,
1999, the Company sold its hardware business to Primax Electronics, Ltd. On
March 2, 1999, the Company acquired Xerox Corporation's ScanSoft subsidiary and
subsequently renamed the Company ScanSoft, Inc. On March 13, 2000, the Company
acquired Caere Corporation ("Caere"). See "Caere Acquisition" note for specific
information on the Caere acquisition.

The accompanying unaudited consolidated financial statements of ScanSoft,
Inc. (the "Company" or "ScanSoft") have been prepared in accordance with
generally accepted accounting principles. In the opinion of management, these
interim consolidated financial statements reflect all adjustments, consisting of
normal recurring adjustments, except with respect to the adjustments made in
relation to the Caere acquisition, necessary to present fairly the financial
position, results of operations, and cash flows at September 30, 2000, and for
the three and nine months ended September 30, 2000 and 1999. Although the
Company believes that the disclosures in these financial statements are adequate
to make the information presented not misleading, certain information normally
included in footnotes prepared in accordance with generally accepted accounting
principles has been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. The accompanying financial statements
should be read in conjunction with the audited financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1999 and the unaudited pro forma financial statements of the Caere
acquisition included in the Registration Statement on Form S-4 filed with the
Securities and Exchange Commission on February 9, 2000.

The results for the three and nine months ended September 30, 2000, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000, or any future period.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities on the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.

BALANCE SHEET COMPONENTS:

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

SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
Inventory:
Raw Materials ...................... $ 521 $ 524
Finished goods ..................... 260 256
------ ------
$ 781 $ 780
====== ======
Other current liabilities:
Accrued compensation ............... $1,944 $ 721
Accrued restructuring .............. 2,383 --
Accrued royalties .................. 801 200
Accrued taxes payable .............. 280 351
Other current liabilities .......... 1,344 571
------ ------
$6,752 $1,843
====== ======

CAERE ACQUISITION:

On March 13, 2000, the Company acquired Caere Corporation, a company that
designed, developed and marketed a range of optical character recognition
software tools, for approximately $48.5 million in cash, 19.0 million shares of
Common Stock of the

6
<PAGE> 7
Company, and the exchange of approximately 4.6 million employee stock options
to purchase Common Stock of the Company in exchange for outstanding employee
stock options of Caere. The common stock issued has been valued using the
average quoted price of common stock for the period a few days preceding and the
day of the consummation of the acquisition. The employee stock options were fair
valued using the Black Scholes option pricing model. In addition, pursuant to a
concurrent non-competition agreement and subject to certain other conditions,
the Company agreed to pay the former President and CEO of Caere on the second
anniversary of the merger the difference between $13.50 and the closing price of
ScanSoft stock at that time, multiplied by the number of beneficial shares owned
by the former executive. The value of this stock price guarantee at the date of
acquisition was approximately $4.0 million and has been included in the total
purchase price of the acquisition. Additionally, in conjunction with the
acquisition, the Company incurred approximately $1.7 million of acquisition
related costs. The purchase price of Caere, including acquisition costs, was
$168.4 million, and was allocated to the assets acquired and liabilities assumed
based on the fair value of Caere's current assets, property and equipment, and
liabilities. The excess of the purchase price over the fair value of tangible
assets acquired has been allocated to intangible assets (in-process research and
development, core technology, developed technology, patents, favorable building
lease, non-compete agreements and acquired workforce) acquired based on an
independent appraisal.

This acquisition has been accounted for under the purchase method of
accounting. Accordingly, the results of operations of Caere and the fair market
value of acquired assets and assumed liabilities have been included in the
financial statements of the Company as of the date of acquisition. The Company
recorded a one-time write-off of $18.3 million in the quarter ended March 31,
2000 relating to the value of in-process research and development acquired as
part of the purchase.

The allocation of the purchase price was as follows (in thousands):

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

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

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

The average percentage of completion of the projects ranged from 50% to 67%
at the date of the acquisition. Revenues were projected to be generated late in
fiscal 2000 for each of the product versions in development at the acquisition
date. If these projects are not successfully developed, future revenue and
profitability of ScanSoft may be adversely affected. Additionally, the value of
other intangible assets acquired may become impaired.

7
<PAGE> 8

The following identifies the intangible assets acquired in connection with Caere
and respective lives (in thousands):

AMOUNT LIFE
------ ----

Goodwill............................... 61,095 6 Years
Core technology........................ 17,905 5 Years
Developed technology................... 16,340 2 Years
Other identified intangible assets..... 10,448 2-5 Years
--------
$105,788

Other identified intangible assets consist of a non-compete agreement, acquired
work force, a favorable building lease agreement, and patents on the Caere
technology. These assets are being amortized over a period of 2, 3, 4 and 5
years, respectively.

During the quarter ended June 30, 2000, the Company, as a result of its
restructuring wrote-off $1,074,000 of acquired work-force and $2,416,000 of a
favorable building lease established as part of the identifiable intangible
assets acquired from Caere. These assets were deemed to be impaired to the
extent employees are to be terminated and facility space is to be vacated in
connection with the June 2000 restructuring actions.

Pro forma Results (unaudited)

The following table reflects the unaudited pro forma results of operations of
the Company assuming that the acquisition of Caere had occurred at the beginning
of each fiscal period presented:

THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>

Revenue ............ $ 13,638 $ 19,050 $ 41,075 $ 68,053
Net loss ........... (7,076) (5,191) (45,686) (35,984)
Net loss per share.. (0.15) (0.11) (0.94) (0.81)
</TABLE>

These unaudited pro forma results of operations include the write-off of the
in-process research and development charge taken in the first quarter and
restructuring and other charges taken in the second quarter. The unaudited pro
forma results of operations are not necessarily indicative of the actual results
that would have occurred had the transaction actually taken place at the
beginning of the periods.

As part of the acquisition, the Company acquired deferred tax assets
amounting to approximately $5,919,000, for which a full valuation allowance was
initially recorded due to the uncertainty of their realization. In accordance
with Financial Accounting Standards Board No. 109 "Accounting for Income Taxes"
("FAS 109"), the Company established a deferred tax liability associated with
the non-deductible acquired intangibles assets excluding goodwill. As a result,
the valuation allowance on the acquired Caere net deferred tax asset as well as
a portion of the Company's valuation allowance on its existing net deferred tax
assets was released. Also in accordance with FAS 109, this reduction in
valuation allowance was accounted for in the purchase accounting and not the
statement of operations during the period ended March 31, 2000.

RESTRUCTURING AND OTHER CHARGES:

In connection with the acquisition of Caere, the Company identified
approximately 46 employees of Caere whose positions would be eliminated
immediately as part of the acquisition. These positions include 22 in research
and development, 14 in general and administrative functions, and 10 in sales and
marketing. Additionally, the former president and CEO position of Caere was
eliminated. As a result, the Company has established as part of the purchase, a
restructuring reserve in the amount of $487,000 for the severance payments to
employees, anticipated to be paid out over the fourth quarter, and a
restructuring reserve of $1,065,000 for the former president and CEO of Caere,
whose severance and benefits will continue over the next 5 years.

The Company is obligated to pay retention bonuses amounting to approximately
$797,000 relating to key employees who will be used in the integration of the
companies. These retention bonuses will be expensed as incurred and have not
been included in the purchase price of the acquisition. Additionally,
approximately 24 employees of Caere have voluntarily terminated their positions.
The Company does not anticipate replacing those individuals.

8
<PAGE> 9
In June 2000, the Company committed to a restructuring plan to strategically
refocus the Company and bring operating expenses in line with net revenues. The
process included a review of all potentially redundant functions and facilities.
As part of this process, the Company determined it would be more cost effective
to eliminate duplicative activities being performed in Los Gatos, California
through relocating certain of these efforts to Peabody, Massachusetts and
Budapest, Hungary. These activities consisted primarily of research and
development, marketing, customer support and general and administrative
functions. In light of this decision, the Company notified 71 employees that
their positions would be eliminated as of June 30, 2000. Of the 71 employees
notified, 6 employees voluntarily terminated their employment and were not
entitled to receive their severance benefits and accordingly, these employees
are not included in the restructuring charge. The remaining 65 employee
positions include 29 in research and development, 13 in general and
administrative functions, and 23 in support and marketing. As a result, in the
second quarter of 2000, the Company recorded a restructuring charge in the
amount of $1,069,000 for the severance payments to these employees and a
restructuring charge of $397,000 for exit costs to be incurred as a result of
exiting the Los Gatos facility. Additionally, the Company wrote-off $3,490,000
of net intangible assets acquired as part of the Caere acquisition including the
acquired work force amounting to $1,074,000 and a favorable building lease
amounting to $2,416,000, which were impaired as a result of the restructuring.

The Company is obligated to pay retention bonuses amounting to approximately
$212,000 relating to key employees who will be used to complete the
restructuring of the company. These amounts are charged to expense as incurred.

During the nine months ended September 30, 2000, the Company paid $635,000
in severance related payments related to the restructuring activities.
Additionally, the Company paid $761,000 relating to retention bonuses for the
nine-month period ending September 30, 2000.

The following table sets forth the 2000 restructuring reserve activity (in
thousands):
<TABLE>
<CAPTION>

EMPLOYEE EXIT INTANGIBLE
RESTRUCTURING AND OTHER CHARGES RESERVE RELATED COSTS ASSETS TOTAL
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Restructuring reserve provided in March 2000 acquisition $ 1,552 $ 1,552
Restructuring and other charges for June 2000 restructuring 1,069 $ 397 $ 3,490 4,956
Non-cash disposals (3,490) (3,490)
Cash payments (635) (635)
------------------------------------------------------------------------ ------- ------- ------- -------
Balance at June 30, 2000 $ 1,986 $ 397 $ -- $ 2,383
------------------------------------------------------------------------ ------- ------- ------- -------
</TABLE>

Restructuring charges of $346,000 in the first nine months of 1999 relate to the
acquisition of Xerox's ScanSoft Subsidiary and the subsequent consolidation of
research and development operations and the move of the Company's headquarters
to Massachusetts, which resulted in the termination of 10 employees in
California. The major components of these costs were approximately $188,000 in
severance costs for the 10 employees and approximately $46,000 for disposed West
Coast equipment. Also included was $82,000 in non-refundable commitments
associated with the West Coast development team, as well as $30,000 in other
exit costs. All such costs have been fully paid as of September 30, 2000.

The Company has accounted for these items using the guidance established in
SEC Staff Accounting Bulletin No. 100 "Restructuring and Impairment Charges" and
Emerging Issues Task Force EITF No. 94-3 "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)", and EITF No. 95-3 "Recognition of
Liabilities in Connection with a Purchase Business Combination". Accordingly,
only those items meeting the requirements of these pronouncements have been
included in the restructuring and purchase price, respectively.

NET INCOME (LOSS) PER SHARE:

Net income (loss) per share is calculated in accordance with the provisions
of Statement of Financial Accounting Standards No. 128 - "Earnings per Share"
(SFAS No. 128). The following details the computation for basic and diluted
income (loss) per share:
<TABLE>
<CAPTION>

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) ........................ $ (7,076) $ 472 $(47,041) $ (2,729)
Basic:
Weighted average common shares
outstanding.............................. 45,963 26,472 40,800 25,220
======== ======== ======== ========
Net income (loss) per share .............. $ (0.15) $ 0.02 $ (1.15) $ (0.11)
======== ======== ======== ========
Diluted:
Weighted average common shares
outstanding.............................. 45,963 26,472 40,800 25,220
Effect of diluted options and warrants ... -- 5,465 -- --
-------- -------- -------- --------
Weighted average common shares
outstanding.............................. 45,963 31,937 40,800 25,220
======== ======== ======== ========
Net income (loss) per share .............. $ (0.15) $ 0.01 $ (1.15) $ (0.11)
======== ======== ======== ========
</TABLE>

9
<PAGE> 10

BANK LINE OF CREDIT:

On March 14, 2000, the Company entered into a one year Credit Agreement (the
"Agreement") with its financial institution that consisted of a $10,000,000
revolving loan (the "Revolver"). Borrowings under the Revolver bear interest at
the rate of one percent (1.0%) per annum above the Prime Rate. The maximum
aggregate amount of borrowings outstanding at any one time is limited to the
lesser of (a) the bank's total commitment and (b) the Borrowing Base. The
Borrowing Base is equal to fifty percent (50%) of eligible accounts receivables
for which invoices have been issued and are payable. As of June 12, 2000, the
Agreement was amended to modify the total commitment by the bank from
$10,000,000 to $5,000,000 and the Borrowing Base requirement was removed. At
September 30, 2000, the Company had $4,300,000 of bank borrowings outstanding,
which reflects a pay-down of $450,000.

Pursuant to the Agreement, the Company is required to maintain certain financial
and non-financial covenants, including certain earnings levels, liquidity
ratios, restrictions on dividends and capital expenditures. Borrowings under the
Agreement are secured by substantially all of the Company's assets. For the
quarter ended September 30, 2000, the Company failed to comply with certain of
its financial covenants and the bank has waived its requirement that the Company
comply thereunder. On October 18, 2000, the Company amended the Agreement with
its lending institution to waive all financial covenants until December 29,
2000, at which time the lending institution has agreed to negotiate new, less
restrictive financial covenants. In conjunction with this amendment the interest
rate was increased by one percent (1.0%) to two percent (2.0%) per annum above
the Prime Rate, and the Company agreed not to re-borrow amounts that had been
repaid. Additionally, the maturity date of the line of credit was extended from
March 12, 2001 until September 30, 2001, and a gradual pay-down schedule was
agreed to. Our ability to meet future financial covenants is contingent upon the
lending institution's willingness to negotiate appropriate financial covenants
for the Company.

COMPREHENSIVE INCOME (LOSS)

Total comprehensive loss was $7.0 million and $47.0 million for the three and
nine months ended September 30, 2000, respectively. Comprehensive loss consists
of net loss and the net changes in foreign currency translation adjustments.
Total comprehensive income (loss) for the three and nine months ended September
30, 1999 equaled net income (loss).

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In March 2000, the Financial Accounting Standard Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues clarifies
the following: the definition of an employee for purposes of applying APB
Opinion No. 25; the criteria for determining whether a plan qualifies as a
non-compensatory plan; the accounting consequence of various modifications to
the terms of previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. The Company
does not expect the application of FIN 44 to have a material impact on the
Company's financial position or results of operations.

In December 1999, the United States Securities and Exchange Commission
("SEC") issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides the SEC staff's views in applying
generally accepted accounting principles to selected revenue recognition issues,
as well as examples of how the staff applies revenue recognition guidance to
specific circumstances. SEC registrants may adopt a change in accounting
principle no later than the first quarter of the fiscal year beginning after
December 15, 1999 (January 1, 2000 for the Company). In June 2000, SAB 101B was
issued by the SEC delaying the implementation date of SAB 101 to the fourth
quarter of 2000. The Company is evaluating the impact of SAB 101 on its
financial position and results of operations and will report the impact, if any,
in the fourth quarter 2000.

10
<PAGE> 11

"Accounting for Derivative Instruments and Hedging Activities-Deferral of the
Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No.
133" was issued. In June 2000, SFAS 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of FASB Statement No.
133" was issued. SFAS 138 does not amend any of the fundamental concepts of
Statement 133, but does address a limited number of issues causing
implementation difficulties for entities that apply SFAS 133. SFAS 133, as
amended by SFAS 137 and SFAS 138, remains effective for fiscal quarters
beginning after January 1, 2001 for the Company, and its adoption is not
expected to have a material impact on the Company's financial position or
results of operations.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD LOOKING STATEMENTS

Certain statements made in this report, as well as oral statements made by
the Company from time to time, which are prefaced with words such as "expects",
"anticipates", "believes", "projects", "intends", "plans" and similar words and
other statements of similar sense, are forward looking statements. These
statements are based on the Company's current expectations and estimates as to
prospective events and circumstances, which may or may not be in the Company's
control and as to which there can be no firm assurance given.

These forward looking statements, like any other forward looking statement,
involve risks and uncertainties that could cause actual results to differ
materially from those projected or anticipated. Such risks and uncertainties are
outlined later in this document and should not be construed as exhaustive. The
Company disclaims any obligation to subsequently revise forward looking
statements or to reflect events or circumstances after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events.
Further discussions of risk factors are also available in the Company's
registration statements filed with the Securities and Exchange Commission. The
Company wishes to caution readers not to place undue reliance upon such
forward-looking statements, which speak only as of the date made.

<PAGE> 12

OVERVIEW

On January 15, 2000, we entered into an agreement to acquire Caere
Corporation, a California based digital imaging software company. The
acquisition was completed on March 13, 2000 and Caere was merged into a
subsidiary of ScanSoft. As a result, ScanSoft has added the OmniPage and
OmniForm family of products to its own product line. The acquisition was
accounted for as a purchase and accordingly, the results of operations of Caere
are included in the Company's financial statements as of the acquisition date.
The Company's results of operations for the nine-month period ended September
30, 2000, include a pre-tax charge of $18.3 million for the value of acquired in
process research and development and amortization of $7.7 million related to
intangible assets recorded as a result of the acquisition. On March 2, 1999, the
Company acquired Xerox's ScanSoft subsidiary and renamed the Company ScanSoft,
Inc. Many of the increases discussed below are related to the inclusion of
ScanSoft's results for the entire nine months in 2000 versus just seven months
in 1999, and to the inclusion of Caere since March 13, 2000.

Our success in the future will depend on our ability to maintain software
gross margins and increase sales of our software products. This will depend in
part on our ability and the ability of our distributors, resellers and OEM
partners to convince end-users to adopt paper and image input systems for the
desktop and to educate end-users about the benefits of our products. There can
be no assurance that the market for our products will develop or that we will
achieve market acceptance of our products. Despite experiencing several quarters
of minor levels of profitability throughout our history, we have incurred annual
net losses since inception. There can be no assurance that we will be able to
reach quarterly profitability or attain annual profitability in the near future.
As of September 30, 2000, we had an accumulated deficit of $130 million.

RESULTS OF OPERATIONS

The following table presents, as a percentage of total revenue, certain
selected financial data for the three and nine months ended September 30, 2000
and September 30, 1999:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>

Revenue: 100.0% 100.0% 100.0% 100.0%

Costs and expenses:
Cost of revenue 21.7% 24.3% 27.1% 23.6%
Research and development 28.1% 20.9% 33.9% 22.4%
Selling, general and admin 50.1% 39.4% 60.1% 44.8%
Restructuring and other charges 0.0% 0.0% 14.2% 1.5%
Gain on sale of hardware business, net 0.0% 0.0% 0.0% (3.8)%
Amortization of goodwill and other intangible
Assets 49.8% 8.0% 45.1% 5.6%
Acquired in-process research and development 0.0% 0.0% 52.2% 17.1%
----- ----- ------ -----
Total costs and expenses 149.7% 92.6% 232.6% 111.2%
----- ----- ------ -----

Income (loss) from operations (49.7)% 7.4% (132.6)% (11.2)%

Other income/(expense), net (1.9)% 0.8% (0.7)% 0.6%
----- ----- ------ -----
Income (loss) before income taxes (51.6)% 8.2% (133.3)% (10.6)%

Provision for income taxes (0.3)% (2.4)% (0.9)% (1.3)%
----- ----- ------ -----
Net income (loss) (51.9)% 5.8% (134.2)% (11.9)%
----- ----- ------ -----
</TABLE>

REVENUE

Net revenue of $13.6 million for the three months ended September 30, 2000
increased by $5.4 million or 66%, from the comparable period in 1999. The
primary increase in revenue was due to the acquisition of Caere Corporation on
March 13, 2000. Revenue growth occurred primarily from increased software sales
through retail channels while growth to a lesser extent also occurred in the
Direct and OEM channels of distribution. OEM license revenue is anticipated to
grow in future quarters as existing relationships are strengthened and new
partnerships are formed. During the quarter the Company announced a worldwide
OEM agreement to bundle its software with the Hewlett Packard (HP) HP ScanJet
6300C Professional Series Scanners.

Revenue for the nine months ended September 30, 2000 increased $12.0 million
or 52% from the comparable period of 1999. During the first nine months of 2000,
the Company took several steps to take full advantage of a growing scanner and
digital imaging market. The first was the previously mentioned acquisition of
Caere and its product lines. In addition, PaperPort 7.0 was released in

<PAGE> 13

the latter half of the second quarter and TextBridge Pro Millenium Business
Edition and the Developer's Kit2000 version 10.0 were also released during the
second quarter. This was offset by a change in the Company's method of
estimating revenue reserves to more closely align reported revenues with end
user purchases, resulting in a reduction of revenue of $3.7 million for the nine
months ended September 30, 2000.

Net revenue by channel in the three months ended September 30, 2000 was 55%
retail, 15% direct, and 30% OEM and multi-user licenses compared to 41%, 16% and
43%, respectively for the same period ended September 30, 1999. The net revenue
breakdown for the nine months ended September 30, 2000, was 51% retail, 19%
direct, and 30% OEM and multi-user licenses compared to 46%, 18% and 36%,
respectively for the same period ended September 30, 1999. The decline in OEM
revenue percent for both the three and nine months ended September 30, 2000, was
a result of Caere's much lower OEM revenue percentage relative to ScanSoft's.

COST OF REVENUE

Cost of revenue consists primarily of material costs, third party royalties,
fulfillment, and salaries for product support personnel. Cost of revenue for the
three months ended September 30, 2000 was $3.0 million or 21.7% of revenue,
compared to $2.0 million or 24.3% of revenue in the comparable period of 1999,
an increase in cost of revenue of 48.5%. Cost of revenue for the nine months
ended September 30, 2000 was $9.5 million or 27.1% of revenue, compared to $5.4
million or 23.6% in the comparable period of 1999, an increase in cost of
revenue of 74.8%. The increase in cost of revenue for both the three and nine
month periods are related to the increased revenue volume experienced by the
Company subsequent to the acquisition of Caere, incremental support costs
associated with duplicative support organizations and higher costs associated
with redundant contracts of the combined organization.

The Company anticipates that as a result of the restructuring actions taken
during the second quarter, it will achieve approximately $1.3 million of
annualized cost savings associated with a reduced support organization and
consolidation of redundant operating contracts of the two organizations. The
Company realized expense reductions of approximately $1.1 million in the third
quarter compared to the three months ended June 30, 2000. These cost savings
were attributed to synergies achieved from the combined entities as well as the
restructuring initiated in the second quarter.

RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses consist primarily of salary and benefit
costs of engineers. Research and development costs were $3.8 million or 28.1% of
revenue in the three months ended September 30, 2000, compared to $1.7 million
or 20.9% of revenue for the same three months in 1999. Research and development
costs for the nine months ended September 30, 2000 were $11.9 million or 33.9%
of revenue, compared to $5.1 million or 22.4% for the same period in 1999. The
increase in research and development spending for both the three and nine month
periods is due to the added software engineering headcount from the acquisition
of Caere on March 13, 2000.

The Company anticipates that, as a result of the restructuring actions taken
during the second quarter, it will achieve approximately $3.1 million of
annualized cost savings, net of incremental head count being added in Budapest
Hungary and Peabody Massachusetts, starting in the fourth quarter 2000. For the
three-month period ending September 30, 2000, the Company realized approximately
$1.0 million in cost savings compared to the three-month period ending June 30,
2000. These cost savings were directly related to the restructuring activities
initiated in the second quarter, as well as the headcount reductions that
occurred during the second quarter in connection with the acquisition of Caere.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling expenses include salaries, commissions, advertising, direct mail,
public relations, trade shows, travel and other related sales and marketing
expenses. General and administrative expenses include personnel costs for
administration, finance, human resources, information systems, and general
management in addition to legal and accounting expenses and other professional
services.

Selling, general and administrative expenses in the three months ended
September 30, 2000 were $6.8 million or 50.1% of revenue, as compared to $3.2
million or 39.4% of revenue for the same period in 1999. Selling, general and
administrative expenses for the nine months ended September 30, 2000 were $21.1
million or 60.1% of revenue, as compared to $10.3 million or 44.8% for the nine
months ended September 30, 1999. The increase in expenses is due primarily from
the acquisition of Caere, including costs associated with the acquisition, as
well as growth in spending to support higher revenue.

The Company anticipates that as a result of the restructuring actions taken
during the second quarter, it will achieve approximately

13
<PAGE> 14

$5.3 million of annualized cost savings, net of incremental head count being
added in Budapest Hungary and Peabody Massachusetts, starting in the fourth
quarter 2000. Additionally, the Company anticipates annual facility related
savings of approximately $1.0 million starting in the fourth quarter.

For the three-month period ending September 30, 2000, the Company realized
approximately $1.9 million reduction in SG&A expense compared to the three-month
period ending June 30, 2000. This reduction was from the restructuring initiated
in the second quarter, tighter expense control and the postponement of marketing
communications until the fourth quarter, as well as the headcount reductions
that occurred during the second quarter in connection with the acquisition of
Caere, and the reclassification of former Caere support costs from SG&A to Cost
of revenue.

<PAGE> 15

OTHER COSTS AND EXPENSES

RESTRUCTURING AND OTHER CHARGES:

In connection with the acquisition of Caere, the Company identified
approximately 46 employees of Caere whose positions were eliminated immediately
as part of the acquisition. These positions included 22 in research and
development, 14 in general and administrative functions, and 10 in sales and
marketing. Additionally, the former president and CEO position of Caere was
eliminated. As a result, the Company established as part of the purchase price a
restructuring reserve in the amount of $487,000, for the severance payments to
employees, anticipated to be paid out in the fourth quarter, and a restructuring
reserve of $1,065,000 for the president and CEO of Caere, whose severance and
benefits will continue over the next 5 years.

The Company is obligated to pay retention bonuses amounting to approximately
$797,000 relating to key employees that will be used in the integration of the
companies. These retention bonuses will be expensed as incurred and have not
been included in the purchase price of the acquisition.

During the quarter ending June 30, 2000, the Company committed to a
restructuring plan to strategically refocus the Company and bring operating
expenses in line with net revenues. The process included a review of all
potentially redundant functions and facilities. As part of this process, the
Company determined it would be more cost effective to eliminate duplicative
activities being performed in Los Gatos, California through relocating certain
efforts to Peabody, Massachusetts and Budapest, Hungary. These activities
consisted primarily of research and development, marketing, customer support and
general and administrative functions. In light of this decision, the Company
notified 71 employees that their positions would be eliminated as of June 30,
2000, of the 71 employees notified, 6 employees voluntarily terminated their
employment and were not entitled to receive their severance benefits;
accordingly, these employees are not included in the restructuring charge. The
remaining 65 employee positions include 29 in research and development, 13 in
general and administrative functions, and 23 in support and marketing. As a
result, the Company has established a restructuring charge in the amount of
$1,069,000 for the severance payments to these employees, which is anticipated
to be paid out in the fourth quarter, and a restructuring charge of $397,000 for
exit costs to be incurred as a result of exiting the Los Gatos facility.
Additionally, the Company wrote-off $3,490,000 of net intangible assets acquired
as part of the Caere acquisition, including the acquired work force amounting to
$1,074,000 and a favorable building lease amounting to $2,416,000, which were
impaired as a result of the restructuring. These restructuring actions should
further reduce future operating expenses by approximately $10 million on an
annualized basis.

The Company is obligated to pay retention bonuses amounting to approximately
$212,000 for key employees who will be used in the consolidation of the
companies. These amounts are charged to expense as incurred.

Restructuring charges of $346,000 in the first nine months of 1999 relate to
the acquisition of ScanSoft, and the subsequent consolidation of research and
development operations and the move of the Company's headquarters to
Massachusetts, which resulted in the termination of 10 employees in California.
The major components of these costs were approximately $188,000 in severance
costs for the 10 employees and approximately $46,000 for disposed West Coast
equipment. Also included was $82,000 in non-refundable commitments associated
with the West Coast development team, as well as $30,000 in other exit costs.
All such costs have been fully paid as of September 30, 2000.

AMORTIZATION OF INTANGIBLE ASSETS AND IN-PROCESS RESEARCH AND DEVELOPEMENT

Goodwill and other intangible assets, and related amortization expense,
primarily represent assets acquired in connection with the Caere acquisition.
The amounts allocated to identifiable tangible and intangible assets associated
with the Caere acquisition, including acquired in-process research and
development, were based on the results of an independent appraisal. Goodwill
represents the amount by which the cost of acquired net assets exceeded the fair
values of those net assets on the date of purchase. Acquired in-process research
and development represented development projects that had not yet reached
technological feasibility and had no alternative future use. Accordingly, the
amount of $18.3 million was immediately charged to expense in the consolidated
statements of operations upon consummation of the acquisition.

15
<PAGE> 16

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

As a result of the second quarter 2000 restructuring actions, certain
intangible assets associated with the Caere acquisition were impaired.
Accordingly, the Company wrote-off $3,490,000 of net intangible assets including
the acquired workforce amounting to $1,074,000 and a favorable building lease
amounting to $2,416,000. After consideration of these write-offs, the Company
expects amortization of goodwill and other intangible assets to be reduced by
$0.3 million to equal approximately $6.8 million on a quarterly basis.

GAIN ON SALE OF THE HARDWARE BUSINESS

In the quarter ended March 31, 1999, the Company sold its hardware business
to Primax Electronics, Ltd., for approximately $6.8 million and reported an
operating gain of approximately $882,000.

OTHER INCOME (EXPENSE), NET

Other income (expense), net consists primarily of interest earned on cash,
cash equivalents and short-term investments offset by interest incurred for
borrowings under credit facilities and short-term notes and exchange gains and
losses.

Other expense, net was $257,000 for the three months ended September 30,
2000, compared with other income, net of $62,000 for the same period in 1999.
The decrease was attributable to higher interest expense on larger bank
borrowings and foreign exchange losses. Other expense, net for the nine months
ended September 30, 2000 was $257,000, compared to other income of $136,000 for
the same period in 1999. This was the result of higher interest expense
associated with amounts borrowed under the line of credit, for the nine months
ended September 30, 2000.

TAXATION

Tax provisions of $36,000 and $344,000 for the three and nine months ended
September 30, 2000 respectively represent taxes for foreign and state
jurisdictions in which the Company does business and for which no net operating
loss carryforwards were available. For the same periods in 1999, we had a tax
provision of $200,000, and $300,000 respectively, representing alternative
minimum taxes due to our recorded losses.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2000, we had cash, cash equivalents and short-term
investments of $5.0 million and a working capital deficit of $4.4 million, as
compared to $5.2 million in cash, cash equivalents and short-term investments
and $7.0 million of working capital

16
<PAGE> 17

at December 31, 1999.

During the nine months ended September 30, 2000, we used $4.7 million of
cash for our operating activities, as compared to $2.3 million for the same
period in 1999. The cash was used to fund payment of restructuring salary and
personnel costs, and other normal operating costs.

During the nine month period ended September 30, 2000, cash provided by
investing activities was $1.2 million as compared to $6.5 million for the same
period in 1999. The decline is due primarily to $6.8 million that was received
for the sale of the hardware business in 1999 and $1.2 million of cash received
with the acquisition of ScanSoft, also in 1999. The Company also received $1.4
million of cash related to the acquisition of Caere in 2000.

During the nine months ended September 30, 2000, cash provided by financing
activities was $3.4 million as compared to $6.6 million used for the same period
in 1999. During the nine months ending September 30, 2000, the Company made an
additional draw of $4.8 million and made payments of $0.5 million on our line of
credit bringing the balance to $4.3 million at September 30, 2000. Additionally,
during the nine month period ended September 30, 2000, we repaid the $1.6
million note payable. The Company also received $0.7 million from proceeds from
stock option exercises and the employee stock purchase plan for the nine months
ended September 30, 2000. This compares to $0.1 million for the same period in
1999.

Our principal sources of liquidity as of September 30, 2000 consisted of
approximately $5.0 million of cash, cash equivalents and short-term investments.
On March 13, 2000, we acquired Caere Corporation for approximately $168 million.
The acquisition consideration consisted of $49 million in cash, $95 million in
ScanSoft common stock and $24 million in stock compensation and other
transaction costs. The cash consideration was paid out of Caere's cash balance
of approximately $50 million. In addition, we have arranged a secured credit
facility, as amended, for $5.0 million, subject to various borrowing
constraints, which has been substantially utilized. Pursuant to the credit
facility, the Company is required to maintain certain financial and
non-financial covenants, as defined, including certain earnings levels,
liquidity ratios, restrictions on dividends and capital expenditures. Borrowings
under the facility are secured by substantially all of the Company's assets. For
the quarter ended September 30, 2000, the Company failed to comply with certain
of its financial covenants and the bank has waived its requirement that the
Company comply thereunder. On October 18, 2000, the Company amended the credit
agreement with its lending institution to waive all financial covenants until
December 29, 2000, at which time the lending institution has agreed to negotiate
new, less restrictive financial covenants. In conjunction with this amendment
the interest rate was increased by one percent (1.0%) to two percent (2.0%) per
annum above the Prime Rate, and the Company agreed not to re-borrow amounts that
had been repaid. Additionally, the maturity date of the line of credit was
extended from March 12, 2001 until September 30, 2001, and a gradual pay-down
schedule was agreed to. Our ability to meet future financial covenants is
contingent upon the lending institutions willingness to negotiate appropriate
financial covenants for the Company.

As a result of the restructuring events undertaken in the second quarter
2000, we anticipate achieving sufficient cost savings and expect to generate
cash from operations during the fourth quarter 2000. Based upon these events and
existing cash balances, we believe that our existing sources of liquidity will
provide adequate cash to fund our operations for at least the next twelve
months. However there can be no assurance that cash generated by operations will
be sufficient to satisfy our liquidity requirements beyond 12 months, and we may
be required to sell additional equity or debt securities, or increase or obtain
additional lines of credit. There can be no assurances that the Company will be
able to sell debt or equity securities or obtain financing sufficient to
continue its planned operations on terms acceptable to the Company.

FOREIGN OPERATIONS:

As a result of the Caere acquisition, in March 2000, the Company significantly
increased its presence in Europe. The Company conducts certain business
transactions in the euro, and will change its functional currencies for the
affected countries to the euro by the end of the three-year transition period.
The conversion to the euro has not and is not expected to have a significant
operational impact or a material financial impact on the results of operations,
financial position, or the liquidity of the Company's European businesses.
Changes in the value of the euro or other foreign currencies relative to the
value of the U.S. dollar could adversely affect future revenues and operating
results. Currently, the Company does not hedge any of its foreign-currency
denominated transactions.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:

17
<PAGE> 18

of APB Opinion No. 25 and among other issues clarifies the following: the
definition of an employee for purposes of applying APB Opinion No. 25; the
criteria for determining whether a plan qualifies as a non-compensatory plan;
the accounting consequence of various modifications to the terms of previously
fixed stock options or awards; and the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 is effective July 1, 2000,
but certain conclusions in FIN 44 cover specific events that occurred after
either December 15, 1998 or January 12, 2000. The Company does not expect the
application of FIN 44 to have a material impact on the Company's financial
position or results of operations.

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires that all derivatives be
recognized at fair value in the statement of financial position, and that
corresponding gains or losses be reported either in the statement of operations
or as a component of comprehensive income, depending on the type of hedging
relationship that exists. In June 1999, SFAS 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement No. 133 - an amendment of FASB Statement No. 133" was issued. In June
2000, SFAS 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an amendment of FASB Statement No. 133" was issued. SFAS
138 does not amend any of the fundamental concepts of Statement 133, but does
address a limited number of issues causing implementation difficulties for
entities that apply SFAS 133. SFAS 133, as amended by SFAS 137 and SFAS 138,
remains effective for fiscal quarters beginning after January 1, 2001 for the
Company, and its adoption is not expected to have a material impact on the
Company's financial position or results of operations.

FACTORS THAT MAY AFFECT FUTURE RESULTS

The anticipated benefits from merging with Caere will depend in part on
whether we can integrate our operations and technologies in an efficient and
effective manner. We cannot guarantee that this will occur. Successful
integration will require integration of each company's products and coordination
of each company's operating procedures, financial controls, development efforts
and sales and marketing efforts. This integration may be difficult to accomplish
smoothly or successfully, and may take longer than we expect. If serious
difficulties are encountered during integration, management will have to divert
its attention from normal business operations to address these issues, which
could have an adverse effect on the surviving corporation's business. In
addition, the merger may cause potential customers to cancel or delay orders as
the result of uncertainty over the successful integration of the two companies.
Furthermore, there could be an adverse effect on employee morale and on the
ability of the surviving corporation to retain key personnel. Failure to
effectively accomplish the integration of the two companies' operations could
have a material adverse effect on the surviving corporation's business,
operating results and financial condition.

The Company's business operates in an intensely competitive environment and
operations are subject to risks and uncertainties. Such risks and uncertainties
include, but are not limited to (1) the loss of, or a significant curtailment
of, purchases by any one or more principal customers; (2) the cyclicality of the
retail software industry; (3) inability to protect the Company's proprietary
technology and intellectual property; (4) the inability to attract or retain
skilled employees; (5) technological obsolescence of current products and the
inability to develop new products; (6) the inability to respond to competitive
technology and competitive pricing pressures; (7) quarterly operating results
that fluctuate and differ materially from one quarter to the next which could
have an impact on the Company's stock price.

There can be no assurance that cash generated by operations will be
sufficient to satisfy our liquidity requirements, and we may be required to sell
additional equity or debt securities, or increase or obtain additional lines of
credit. The sale of additional equity or convertible debt securities may result
in additional dilution to our stockholders. It may be difficult to sell
additional equity or obtain debt financing, and this could result in significant
constraints on the Company's ongoing investments to grow revenue and develop new
products.

For further discussion regarding these and other risks, refer to the Company's
Annual Report on Form 10-K for the year ended

18
<PAGE> 19

December 31, 1999 and the Company's Prospectus/Proxy Statement dated February 9,
2000.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

<PAGE> 20

PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

The exhibits listed on the Exhibit Index hereto are filed or incorporated
by reference (as stated therein) as part of this report on Form 10-Q.

(b) Reports on Form 8-K

None

<PAGE> 21

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this Report on Form 10-Q to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Peabody, State of
Massachusetts, on November 13, 2000.

SCANSOFT, INC.

By: /s/ Gerald C. Kent Jr.
------------------------------
Gerald C. Kent, Jr.
Chief Accounting Officer
And Corporate Controller

<PAGE> 22

EXHIBIT INDEX

Exhibits (numbered in accordance with Item 601 of Regulation S-K)

EXHIBIT
NO. DESCRIPTION OF EXHIBITS
------- -----------------------

2.1(1) Agreement and Plan of Merger dated December 2, 1998, between
Visioneer, Inc., a Delaware corporation, and ScanSoft, Inc.,
a Delaware Corporation.

2.2(2) Agreement and Plan of Reorganization, dated January 15, 2000,
by and among ScanSoft, Inc., a Delaware corporation, Scorpion
Acquisitions Corporation, a Delaware corporation and a
wholly-owned subsidiary of ScanSoft, and Caere Corporation, a
Delaware corporation.

3.2(3) Bylaws of Registrant

3.2(4) Amended and Restated Certificate of Incorporation of Registrant.

4.1(4) Specimen Common Stock Certificate.

4.2(5) Preferred Shares Rights Agreement, dated as of October 23, 1996,
between the Registrant and U.S. Stock Transfer Corporation,
including the Certificate of Designation of Rights, Preferences
and Privileges of Series A Participating Preferred Stock, the
form of Rights Certificate and Summary of Rights attached thereto
as Exhibits A, B and C, respectively.

4.3(6) Voting Agreement dated March 2, 1999 between Xerox, Xerox Imaging
Systems, Inc., Visioneer, Inc. and several holders of Visioneer
common stock.

10.1 Employment Agreement dated August 21, 2000, by and between
ScanSoft, Inc. and Paul A. Ricci.

10.2 Employment Agreement dated August 21, 2000, by and between
ScanSoft, Inc. and Michael K. Tivnan.

27.1 Financial Data Schedule.

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(1) Incorporated by reference from the Registrant's Registration Statement on
From S-4 (No. 333-70603) filed with the Commission on January 14, 1999.

(2) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 (No. 333-96487) filed with the Commission on February 9, 2000.

(3) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (No. 333-98356) filed with the Commission on October 19, 1995.

(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (No. 333-74343) filed with the Commission on March 12, 1999.

(5) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 (No. 333-96487) filed with the Commission on February 9, 2000.

(6) Incorporated by reference from the Registrant's current Report on Form 8-K
dated October 30, 1996.