ITEM 1. BUSINESS.
Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Item 1, the section entitled "Risk Factors" and Item 7.
Caere(R) Corporation ("Caere" or the "Company") designs, develops, manufactures, and markets optical character recognition (OCR) software and hardware for converting scanned and faxed images into computer usable text, as well as desktop forms and information management products. For many applications, the Company's products provide a low cost accurate alternative to manual data entry, which is slow, tedious, and error prone.
In December 1996, Caere acquired Recognita Rt. ("Recognita"), a Hungarian corporation that provides OCR products. The acquisition was accounted for using the purchase method of accounting, and, accordingly, the operating results of Recognita are included in the consolidated results of the Company since the date of acquisition.
TRANSITION OF BUSINESS MODEL
During 1996, Caere continued the transition of its business model due to the changing dynamics of the marketplace. In the past, OCR was primarily a "niche" market characterized by relatively high prices and low unit volumes. Driven by the increased power of personal computers, new scanner products with lower prices, continuing improvements in OCR accuracy, and the education of the marketplace, scanning and OCR solutions continue to reach the mainstream.
In the fourth quarter of 1994, Caere began to "bundle" versions of its OmniPage(R), OmniPage Limited Edition(TM), and WordScan(R) software recognition products with scanner products from various manufacturers. The Company's objective in bundling its software products with scanners was to expand the overall market for OCR software by providing a larger number of scanner purchasers with experience in the advantages of optical character recognition. "Light" versions -- with limited capabilities -- are now bundled with most scanners being sold. This aggressive seeding of the growing base of scanner owners has greatly expanded the number of Caere product users. The success of this business model, compared to Caere's former model of selling its software primarily at higher prices with lower unit volumes, will depend upon a decision by a significant proportion of customers who first receive OCR software in a bundled form to upgrade to a newer or more fully featured version of the Company's software. Such an upgrade is typically sold at a substantially lower price than the price of a fully featured non-upgrade product.
The Company shipped more than 2,100,000 bundled units in 1996, compared to approximately 1,200,000 bundled units in 1995. The "bundle and upgrade" business model resulted in increased revenues and gross margin from software products in 1996 compared to 1995, and an increase of 67% in unit sales of combined software products for the same comparison periods. The Company believes that bundles and upgrades will become a larger portion of its total revenues and unit sales in the future.
There can be no assurance that Caere's continued transition to the "bundle and upgrade" business model will be successful and provide sufficient increases in unit volume in the future to offset reduced per-unit revenue and gross margin. In addition, customers using the bundled products may defer or forego the purchase of Caere's more fully featured versions of OmniPage and WordScan products if they find that the bundled products satisfy their recognition needs.
PRODUCTS
The Company offers a product line designed to accommodate the diversity of information and data entry requirements. Caere's products fall into two general categories:
(1) SOFTWARE: Software products for the information management market that offer a range of OCR, forms, and document management products that provide personal computer users tools to manage, intelligently and efficiently, the documents, images, forms and faxes that cross their desktops.
(2) HARDWARE: Hardware products for the data capture market, which include bar code scanners and OCR readers for transaction processing applications such as high-volume data entry and check verification. Customers of these products include retail establishments, government agencies, banks, utility companies, and other organizations. Additionally, the Millennium Series(R) provides both hardware and software solutions for high-volume commercial OCR applications.
Caere's products can be used with a range of computer systems, such as IBM, IBM-compatible, and Apple Macintosh personal computers. Each product is designed to accomplish the same overall goal: to improve the speed, accuracy, and simplicity of information management.
SOFTWARE PRODUCTS
OmniPage Professional(R)
Caere's flagship product, OmniPage Professional for Windows and Windows 95, is a customizable, fully featured page recognition solution for power users. OmniPage Pro(R) is designed for the text handling professional who needs more than basic OCR capabilities. OmniPage Pro is an OCR product that allows the user to recognize, edit, and save complex documents containing text and images in their original, full page formats. Using Caere's True Page(R)technology, the user can edit graphics contained on a recognized page simply by clicking on the image. OmniPage Pro utilizes a combination of technologies, including neural networks, linguistic analysis, character experts, and grayscale data to improve accuracy on degraded documents.
OmniPage Professional for Macintosh includes all of the features found in OmniPage Pro for Windows. It also offers many advanced System 7 capabilities, including support of Publish, which allow users to scan a document once and electronically publish it to subscribers on a network. The program also supports Apple Events, which allows other software programs to access OmniPage Pro.
OmniPage Limited Edition
OmniPage Limited Edition is a limited feature version of OmniPage that allows an end user to perform OCR on a scanned document and save the document to a file. OmniPage Limited Edition is bundled with most scanners offered by the Company's scanner partners. The product is designed to allow the scanner purchaser to experience the advantages of optical character recognition in order to encourage the purchaser to upgrade to a fully featured product.
OmniPage Direct(TM)
Rounding out the OmniPage product family is OmniPage Direct, a lower-cost, easy to use version of OmniPage that scans text directly into a word processing or spreadsheet program. OmniPage Direct offers direct access and input capabilities from both Windows and Macintosh software, reducing the complexity of scanning text and numbers into other applications.
WordScan Plus
WordScan Plus, developed by Calera, is a full-featured and accurate page recognition product that integrates with the most popular products being used in Windows. Features like OLE 2.0 support, drag and drop recognition capability, and a Chameleon Toolbar(TM) that automatically takes on the look and feel of the
user's office suite enable WordScan Plus to benefit from popular Windows programs. WordScan Plus directly integrates with all leading office suites, word processors, electronic mail systems, and facsimile applications.
Recognita Plus(R)
Recognita Plus, developed by Recognita, is a leading, full-featured, multilingual, and font-independent OCR software product that integrates with most popular word processing, desktop publishing, and spreadsheet applications available for Windows. Recognita Plus includes Self Assertion Technology(TM), which provides improved character recognition using a two-step reading process. Recognita Plus also provides OCR training for use on severely degraded documents or stylized typefaces. The product can also recognize text in more than 100 languages with the addition of its Language Enhancement(TM) Package.
PageKeeper(R)
PageKeeper, a document management software solution, incorporates leading technology such as "weighted relevance searching" and "document similarity" as it examines the content of the documents under review. PageKeeper takes information from a local hard disk, network, or scanner and creates a supercompressed database of both text and images. PageKeeper incorporates the OmniPage AnyFont(R) recognition capability to convert scanned documents into computerliterate files automatically. Because PageKeeper stores both text and images, users can electronically file documents in their original format. Magazine articles with charts and graphs, datasheets with illustrations, or letters with signatures can be stored using minimal disk space. PageKeeper automatically indexes the database, eliminating the need to manually index or assign keywords to the information. It presents the results of search requests in the order of relevance to original search requests using its weighted relevance retrieval feature.
OmniForm(R)
OmniForm converts paper forms to electronic forms with the click of a button. OmniForm creates an electronic version using some of Caere's OCR technologies by simply scanning or faxing documents into a computer. OmniForm users also can design their own forms, complete with fonts, graphics, and logos, using the custom toolset and Form Assistant(TM). In addition, OmniForm allows for efficient completion and processing of forms by accepting input, performing calculations, validating entries and creating databases which can be searched, sorted, imported, and exported to popular database applications.
OmniForm Internet Publisher(TM)
OmniForm Internet Publisher is the first paper-to-electronics forms solution for intranets and the Internet. The product converts existing paper forms to electronic versions, retaining and recognizing the various form elements on the form, bridging the gap between the paper world and the electronic world. The product allows users to save the forms to a variety of Web-ready formats incorporating such form intelligence as field validation and calculations, so that companies can collect and distribute data-associated business transactions such as invoices, purchase orders, expense reports, or questionnaires.
License of Technology
In addition to the application products described above, Caere continues to license its OCR technology to a broad range of computer equipment manufacturers, systems integrators, and developers for inclusion as components in more complex end user products, including document management and retrieval systems, forms processing systems, resume screening systems, and standalone systems.
The chart below shows system requirements and suggested retail price for the Company's significant software products.
SELECTED SOFTWARE PRODUCTS
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* Suggested Retail Price as of March 1, 1997.
** Estimated Retail Price as of March 1, 1997.
Note: All Caere products support a wide range of output file formats and scanners. Output file formats include, but are not limited to: WordPerfect, Microsoft Word for Windows, Lotus 1-2-3, and Microsoft Excel. Supported scanners include, but are not limited to: Hewlett Packard, Microtek, Epson, Apple, Canon, and Fujitsu.
PAGE RECOGNITION PROCESS
The process by which Caere's recognition products recognize text involves converting the electronic output of a scanner into computer usable files through a series of complex software algorithms. The electronic image produced by the scanner is comprised of white or black picture elements (pixels), usually 90,000 pixels per square inch, each rendered to the computer as a 0 or a 1, representing either a white or a black pixel. Before the application of recognition products such as OmniPage, a scanner's electronic output could be displayed and manipulated only as an image on a computer's monitor; the computer did not recognize that image as a data file usable in an application program such as a word processor or spreadsheet.
The graphic below illustrates the process by which scanned text or numeric data is converted into computer usable form by the Company's OmniPage, WordScan, and Recognita products.
[ARTWORK HERE]
Caere's products recognize an image in two steps. First, they analyze the image of the page to determine which parts are text and numeric data and determine the structure of the page layout. Tables, columns, and paragraphs are identified and located. They then examine and identify the characters and produce a file of the character data contained in words, including page formatting information such as tables, columns, paragraphs, spacing, bold, italics, and underlines that are necessary to allow manipulation of the data as a text file.
OmniPage Pro employs a combination of technologies, referred to as Caere's 3D OCR(TM) and AnyFont technologies, to achieve the highest degree of accuracy on many different types of documents. OmniPage Pro is the first OCR product to utilize grayscale information to analyze characters the way a human eye does. Character experts view certain character attributes like a closed loop or crossed downward stroke to identify the unique set of features inherent in each character. Neural networks have been developed on powerful mainframe computers to "learn" what makes up one character versus another, a methodology known as "feature recognition." Caere's page recognition products analyze each character image according to proprietary algorithms. Feature recognition enables the OmniPage products to provide the AnyFont capability that recognizes text in almost any type style and size.
HARDWARE PRODUCTS
OCR Systems
Caere has produced high-quality handheld and slot-reader OCR systems since 1977. This line of data capture OCR systems reads single lines of characters. These desktop systems --consisting of an input device, such as a wand, slotreader or motorized slot-reader, a controller, and an interface cable-- are designed for transaction processing applications that do not require variable font recognition technology, but demand extremely high accuracy. Common applications involve entering customer account numbers or data from billing documents into a computer. Caere's systems accelerate transaction processing, while reducing operator fatigue and key entry errors.
Caere's 800 Series Combo Reader, which works with a wide variety of computers, integrates OCR, bar code, and magnetic stripe reading capabilities in a single unit. This provides cost-effective and versatile functionality for a wide range of applications in remittance processing, banking, and point-of-sale environments. The 800 Series is also widely used by government organizations, post offices, and the public utility industry. The U.S. Government, for example, creates military rosters by reading social security numbers, post offices scan certified mail article numbers, and Caere's electric, gas, and telephone utility customers use the 800 Series to accelerate payment processing.
In 1996, Caere introduced the Model 1200 Travel Document Reader(TM), a product designed specifically to read passports, identity cards, and other machine readable travel documents that meet certain industry standards. The Travel Document Reader employs Caere's exclusive Quadratic Neural Network(TM) OCR technology, which improves recognition accuracy by plotting dozens of properties of each character on a multidimensional map. Adding a 32-bit microprocessor and programmable Flash memory, the Travel Document Reader offers accuracy, speed, and program flexibility in a compact package.
Caere's 1500 Series Document Processor has all the capabilities of the 800 Series, but processes documents in batches at a rate of over 3,000 per hour. It is the smallest desktop reader/sorter of its type, with many features only found on high-end machines.
Historically, a significant portion of Caere's OCR data capture business has been the result of original equipment manufacturer (OEM) sales; that is, sales to firms that purchase Caere's OCR data capture technology and then integrate it into their own products.
Bar Code Systems
Bar code readers recognize documents printed with series of vertical bars and spaces that represent data. They are used in high-volume transaction processing applications, such as point-of-sale operations, where human readability of data is not necessary. Bar code systems tolerate lower-quality media than limited-font OCR systems, and are typically less expensive than OCR systems. Caere's bar code product line, introduced in 1983, includes both stand-alone decoders that can be attached externally to personal computers, and internal board-level decoders used in personal computers for cost and space savings.
Caere bar code products cater to the higher-end of the market with feature-rich decoders and one of the industry's first five-year warranties. Caere's decoders are used in manufacturing, retail point of sale, inventory, asset tracking, and a myriad of applications where value added resellers need more functionality from bar code readers than just decoding.
Caere's Easy-Scanner(TM) 1000 and 2000 Series bar code systems are decoder/wedges that can accommodate several input devices and connect easily to keyboard ports for simple interfacing to over 350 different types of computers and terminals. With three input ports, these decoder/wedges can accept input from a bar code wand, CCD, laser, badge reader, or magnetic stripe reader and/or serial data from portable data terminals and scales. Any data received can be filtered for acceptance, then transmitted, re-formatted, or rejected to fit the host application with over 90 built-in data editing commands. The Easy-Scanner also features multiple output ports to accommodate a variety of interfaces such as RS-232, parallel, and over 350 keyboard wedge protocols.
The Model 1731 Integrated Laser, one of the most versatile and effective bar code scanners on the market today, combines most of Caere's interfacing and data editing features with a high-performance handheld laser scanner from PSC, Inc., a leading bar code laser manufacturer.
M/Series II OCR Accelerator Board
An OCR accelerator board available for Windows 3.1x and Windows 95 PC users. Supported by the M/Series Professional application software and through Caere's Professional Developer's Kit 6.1, the M/Series II OCR Accelerator Board converts images into text at throughput rates of up to 750 pages per hour or three times faster than the previous board from Caere. For even faster throughput, multiple M/Series II OCR Accelerator Boards can be run in parallel in the same PC. The M/Series II OCR Accelerator Board includes the new M/Text OCR Engine, which reduces errors by as much as 50 percent from previous releases.
M/Series Professional OCR Server for Windows NT
A software application that runs on a Windows NT Server and/or workstation and manages M/Series Professional scan, zone, edit and export functions from Windows 3.1x and Windows 95 clients on a network. Rapid image to text conversion (OCR) is performed on the server, using highly accurate single or multiple M/Text OCR software engines.
M/Series Professional Software-Windows 3.1 and Windows 95
Available for use with the M/Series II OCR Accelerator Board, the M/Series Professional software allows users on a network to simultaneously capture documents, zone fields or templates, edit text created by the OCR process and export files to popular output file formats.
Professional Developer's Kit 6.1
Available as a set of DLLs, VBXs and OCXs for Microsoft Visual Basic and Microsoft Visual C/C++ developers, the Professional Developer's Kit 6.1 uses a similar API to previous Caere/Calera Developer's Kits, allowing programmers commonality in function calls from previous releases. New features supported in the 6.1 release include the ability to get character choices and recognition confidence level values. Also included with the Professional Developer's Kit 6.1 is a copy of the new M/Text OCR engine, with support for 13 different languages. The kit contains both 16-bit and 32-bit libraries.
Visual Developer's Kit 6.1
A subset of the Professional Developer's Kit 6.1, the Visual Developer's Kit contains the VBXs and OCXs for developers who program in the Microsoft Visual Basic environment.
The chart below shows typical applications, features, available interfaces, and input devices for selected Caere OCR and bar code transaction processing products.
DISTRIBUTION AND SUPPORT
Domestically, the Company markets its software products through distributors, including Ingram Micro, Merisel, Tech Data, computer superstores such as Best Buy, CompUSA, Computer City, and Egghead, mail order houses including PC Connection, MicroWarehouse, and Computer Discount Warehouse, and office superstores such as OfficeMax and Office Depot. Caere also markets its software products directly to end user customers by outsourcing telemarketing and order fulfillment services to Softbank Services Group. High-speed and integrator products are primarily sold through Law Cypress Distributing Company, which works with the Company to serve value-added resellers and systems integrators of imaging products.
Sales of software products to Ingram Micro represented approximately 28%, 22%, and 23% of the Company's net revenues during 1996, 1995, and 1994, respectively. Sales of software products through Softbank Services Group represented approximately 15%, 9%, and 2% of the Company's net revenues during 1996, 1995, and 1994, respectively. Should either of these customers have a significant change in its quarterly buying pattern or its financial condition, the Company could experience a material adverse impact on its business and financial results. In addition, there are increasing numbers of companies competing for access to distribution channels, and distributors and retailers often carry competing products. Retailers of Caere's products typically have a limited amount of shelf space and promotional resources for which there is intense competition. There can be no assurance that distributors and retailers will continue to provide the Company's products with adequate levels of shelf space and promotional support. Failure to do so would have a material adverse effect on the Company's results of operations.
The Company markets its transaction processing OCR and bar code products primarily through independent distributors, value-added resellers ("VARs"), and hardware OEMs. The Company's agreements with OEMs typically grant an OEM the right to distribute the Company's products with the OEMs' microcomputers and other data collection equipment. VARs purchase the Company's products and incorporate them into systems integrated with the products of other manufacturers.
Internationally, the Company's products are sold through distributors. At December 31, 1996, the Company had distributors servicing Western and Eastern Europe, Canada, Australia, New Zealand, South Korea, Mexico, and Japan. The Company's international revenues are subject to certain risks, such as export controls, import restrictions, and other governmental regulations. The Company is not currently affected adversely by such controls or regulations and is not aware of pending changes in export regulations that would adversely affect its international business or its ability to collect foreign receivables. International revenues in 1996, 1995, and 1994 were approximately $16,391,000, $15,154,000, and $18,125,000, respectively. In most cases, the Company bills its international customers in U.S. dollars; therefore, such revenues are not subject to foreign currency fluctuations. However, fluctuations in exchange rates could affect demand for the Company's products by causing their prices to be out of line with products priced in the local currency. The Company's international revenues are subject to certain risks, such as export controls, import restrictions, longer payment cycles, greater difficulties in accounts receivable collections, and the requirement of complying with a wide variety of foreign laws. Although Caere has not previously experienced any difficulties under foreign law in exporting its products to other countries, there can be no assurance that the Company will not experience such difficulties in foreign countries in the future. Any such difficulties would have a material adverse effect on the Company's international sales. The Company is not currently affected adversely by such controls or regulations and is not aware of pending changes in export regulations that would adversely affect its international business or its ability to collect foreign receivables.
The Company's agreements with its distributors generally provide for a limited right of return, with the distributor receiving full credit for the product's purchase price, less any discounts, against a purchase order of equal or greater value. The Company monitors its returns and records provisions for estimated returns as shipments are made. During 1996, 1995, and 1994, returns represented 3.2%, 3.7%, and 4.3% of revenues, respectively. Although Caere believes that it provides adequate allowances for returns, there can be no assurance that actual returns will not exceed the Company's allowances. Any product returns in excess of recorded allowances could result in a material adverse effect on operating results of the Company.
The Company has a domestic sales and support staff of 50 employees located throughout the United States. During 1992, the Company established a European sales office, Caere GmbH, in Munich, Germany. In December 1996, the Company acquired Recognita Rt., a Hungarian provider of OCR and forms software solutions. Domestically, information management customers who register with the Company currently receive limited hotline technical support and product information at no cost. Additional technical support services are available on a "fee for support" basis thereafter. Outside of the U.S., information management customers currently receive technical support from a variety of Caere partners on a non-fee basis. The Company warrants to end users that software disks are free from media defects for three months. OCR and bar code hardware customers receive free telephone support, including assistance with installation, programming, and trouble shooting. OCR hardware products are warranted for one year, while bar code hardware products are warranted for between one and five years. In addition, the Company provides hardware customers with spare parts and repair services. OCR and bar code hardware customers also may purchase annual service contracts under which the Company performs service work as needed for the duration of the service contract.
COMPETITION
The information management market is highly competitive and subject to rapid change along with constant pressure to reduce prices. The Company believes that the principal competitive factors in the software products market include accuracy, ease of understanding and use, product reliability, tolerance for poor media, product features and functions, price/performance characteristics, brand recognition, and quality of product support. Caere's competition within the microcomputer software industry ranges from large
corporations to small independent software vendors. Caere also expects to encounter continued competition both from established companies and from new companies that are now developing, or may develop, competing products. Competition in the software products market can be grouped into the following categories:
The OmniPage, WordScan, and Recognita families of page recognition products contend with competition in two markets. First, several companies offer packaged OCR application programs through the retail distribution channel. These include Xerox Imaging Systems and several small independent software vendors. The Company faces significant price competition in the retail channel. The second competitive market for the OmniPage family of recognition products is the OEM and reseller market in which companies license OCR technology to incorporate into different application software products or "bundle" the technology with related hardware products such as scanners or fax modems. Competitors include Xerox Imaging Systems and several small independent software vendors. The Company experiences significant price competition in the OEM market and expects this to continue. In addition, the "bundled" OCR products themselves present competition to the Company's fully featured shrinkwrap product.
PageKeeper has several direct competitors offering competing products in the growing desktop document management market. These competing products include, but are not limited to, PaperPort Deluxe by Visioneer, Paper Master by Documagix, and Pagis by Xerox Imaging Systems. With decreasing scanner prices driving affordable scanning solutions into the mainstream, Caere expects to face increasing competition in this product category from a variety of software developers in the future.
OmniForm competes against various products in the electronic forms market. In the forms creation segment, where OmniForm's technology takes an existing paper form and converts it into an electronic version, OmniForm has no competition. In the forms design and print segment of the electronic forms market, OmniForm competes with products such as Form Tool Gold by IMSI. In the form filling and submit segment of the electronic forms market, OmniForm competes with products including JetForm and FormFlow by JetForm. And finally, in the Internet/intranet publish and submit segment of he electronic forms market, OmniForm competes only with JetForm by JetForm.
The Company believes that the principal competitive factors in the hardware products market include accuracy, tolerance for poor media, product features and functions, and reliability. Price is also an important factor in the bar code market. The major competition in the OCR segment of the Company's hardware business is Siemens CGK. In the bar code segment of the hardware business there are numerous competitors, including Symbol Technologies.
Many of the Company's competitors have substantially greater financial, marketing, recruiting and training resources than the Company. There can be no assurance that the Company will be successful in competing in the information management market.
PRODUCT DEVELOPMENT
The development and enhancement of the Company's OCR and desktop document management products have historically absorbed and are expected to continue to consume the greatest part of the Company's development effort. The Company believes that it must continue to upgrade and enhance its existing products to ensure that its products remain competitive.
Certain products sold by the Company through its Caere Affiliate Publishing(TM) (CAP) program are developed by and remain the property of third parties. Caere maintains exclusive rights to market those products for the term of the license agreement in exchange for a royalty. Currently, OmniForm is the only Caere product being sold through the CAP program.
During 1996, 1995, and 1994, research and product development expenses were approximately $7,069,000, $7,915,000, and $9,072,000, respectively. In addition to internal product development, the Company incorporates software produced by other companies into its products. All such incorporation or use is pursuant to licensing agreements. See also "Product Protection." There can be no assurance that the
research and development expenses incurred will not exceed development budgets or that new products will achieve market acceptance and generate sales sufficient to offset development costs. There also can be no assurance that such license agreements for incorporated third party software will continue to be available to the Company on acceptable terms.
From time to time, the Company has experienced delays in product development and "debugging" efforts, and could experience such delays in the future. Significant delays in developing, completing, or shipping new or enhanced products could materially adversely affect the Company's financial results. Furthermore, as the Company's products become more complex, development cycles become longer and more expensive. There can be no assurance that the Company will be able to respond effectively to technological changes or new product announcements by others, or that the Company's product development efforts will be successful.
INVESTMENT IN ZYLAB INTERNATIONAL, INC.
In November, 1995, Caere invested $2.4 million for a 19.9% ownership stake in ZyLAB International, Inc. ("ZyLAB") with an option to purchase the remaining 81.1%. ZyLAB is a developer of full text indexing and retrieval software that simplifies the process of searching large volumes of information from a variety of sources. Due to ZyLAB's failure to achieve its business plan, Caere recorded a one-time charge of $2,616,000 to write-down its investment in ZyLAB in 1996.
BACKLOG
The majority of the Company's net revenues in a particular quarter has typically resulted from orders booked in that quarter. The Company considers backlog to be orders received and due to be filled within six months. Orders included in backlog typically may be canceled or rescheduled by customers without significant penalty. The Company's backlog at December 31, 1996, was approximately $694,000, as compared to backlog at December 31, 1995, of approximately $449,000. Backlog primarily represents orders for the Company's hardware products, which represented approximately 16% of net revenues during each of 1996 and 1995. There is typically little or no backlog for the Company's software products, as these products ship as soon as orders are received. Backlog as of any particular date should not be relied upon as indicative of the Company's net revenues for any future period.
MANUFACTURING AND SUPPLIERS
The Company's manufacturing operations for its OCR and bar code business products and its M/Series Professional Card Systems consist of final assembly, test, burn in, and quality control for its systems, subassemblies, and components. Components for products are procured by the Company and then supplied to third party contractors. Many of these components are tested and burned in prior to delivery to contractors to reduce failure rates. Major subassemblies such as printed circuit boards are contracted to third parties for assembly and initial testing.
Most of the components used in the manufacture of the Company's products are available from multiple sources of supply. Certain components used in the manufacture of the Company's OCR products are currently available only from a single source. Although the Company generally maintains a several-month inventory level of these components, failure of a single-source supplier to deliver required quantities of such materials could materially and adversely affect the Company's operating results. The Company believes that, if necessary, it could develop alternative sources of supply for these components and parts, or re-engineer the products. However, any delays in developing such alternative sources of supply or in the re-engineering of the products could have a material adverse effect on the Company's results of operations.
PRODUCT PROTECTION
The Company relies upon proprietary technology, trade secrets, know-how, continuing technological innovations and licensing opportunities to maintain its competitive position. The Company attempts to protect its technology and trade secrets with patents, copyrights, trade secret laws, technical measures and non- disclosure agreements. The Company's policy is to file patent and copyright applications to protect technology, inventions and improvements that are important to the development of its business. The Company has been issued a series of patents which directly relate to its products. Assurance cannot be given, however, that any patents issued to the Company will not be challenged, invalidated or circumvented or that the rights granted by the patents will provide competitive advantages to the Company.
In order to protect its ownership rights in its software products, the Company licenses such products to OEMs and resellers on a non-exclusive basis with contractual restrictions on reproduction, distribution and transferability. In addition, the Company generally licenses its software in object code form only. The Company licenses its software products to end users by use of a "shrink-wrap" customer license that restricts the end user to personal use of the product. Despite these contractual restrictions, it may be possible for competitors or users to illegally copy the software or obtain information which the Company regards as proprietary.
The Company also relies on trade secrets and proprietary know-how. The Company has been, and will continue to be, required to disclose its trade secrets and proprietary know-how to employees and consultants. Although the Company seeks to protect its trade secrets and proprietary know how by entering into confidentiality agreements with such persons, there can be no assurance that these agreements will not be breached, that the Company would have an adequate remedy for any breach, or that the Company's trade secrets will not otherwise become known or be independently discovered by competitors.
Because of technological developments in the industry in which the Company markets its products, it is possible that certain of the Company's products may infringe third party proprietary rights. From time to time the Company has received, and in the future may receive, notices of claims of infringement. In response to these claims, the Company may have to obtain licenses for an allegedly infringing product or stop selling such product and be liable for damages. However, there can be no assurance that any required licenses or rights could be obtained on commercially reasonable terms.
In addition, Caere has developed products in the past that incorporate technology based on licenses received from third parties. The Company's ability to continue to develop and commercialize its products will be affected by its ability to renew existing technology licenses and to obtain technology licenses from third parties in the future. There can be no assurance that the Company will be able to renew its current licenses or obtain any necessary licenses in the future. The failure to renew existing licenses or to obtain any licenses that may be required in the future could have a material adverse effect on the Company.
Policing unauthorized use of technology is difficult, especially in the software industry. Software piracy can be expected to be a persistent problem for the software industry for the foreseeable future. Such piracy can be particularly egregious in international markets in which the Company distributes its products. The Company believes that, due to the rapid pace of technological change in the industry, factors such as knowledge, ability, frequent product enhancements, timeliness and quality of product support and the experience of the Company's employees are more significant as a means to protect the Company's competitiveness than patent, copyright and trade secret protection.
EMPLOYEES
As of December 31, 1996, Caere employed 272 people. None of the Company's employees is represented by a labor union. The Company has experienced no work stoppages and believes that its employee relations are good. The Company has utilized the services of consultants, third-party developers, and other vendors extensively in its sales, development, and manufacturing activities.
Competition in the recruiting of personnel in the computer and data recognition industry is intense. The Company believes that its future success will depend in part on its continued ability to hire and retain qualified management, marketing, technical employees, and independent contractors. There can be no assurance that the Company will be able to attract and retain enough qualified employees. Caere does not carry any key person life insurance with respect to any of its personnel.
RISK FACTORS
Fluctuating Revenues and Operating Results
Caere's revenues and operating results have fluctuated in the past and the Company's future revenues and operating results are likely to do so in the future, particularly on a quarterly basis.
Caere's experience has been that a disproportionately large percentage of shipments has occurred in the third month of each fiscal quarter and that shipments tend to be concentrated in the latter half of that month. Backlog early in a quarter is not generally large enough to assure that Caere will meet its revenue target for any particular quarter. A shortfall in shipments at the end of any particular quarter may cause the results for that quarter to fall significantly short of anticipated levels.
The Company's quarterly operating results may continue to fluctuate due to numerous other factors. Some of these factors include the demand for the Company's products, seasonality, customer order deferrals in anticipation of new versions of the Company's products, the introduction of new products and product enhancements by the Company or its competitors, including the effects of filling the distribution channels following such introductions and of potential delays in availability of announced or anticipated products, price changes by the Company or its competitors, product sales mix, timing of acquisitions and associated costs, and timing of significant marketing and sales promotions.
Lack of Product Revenue Diversification
Caere derived approximately 72% of sales in 1996 and 69% of sales in 1995 from the OmniPage and WordScan line of products. Caere expects that these software products will continue to account for a majority of the Company's sales in the future. A decline in demand for these products as a result of competition, technological change or other factors would have a material adverse effect on the Company's results of operations.
Mature Markets for Certain OCR Products
For fiscal years ended December 31, 1996, 1995, and 1994, Caere derived approximately 14%, 23% and 15%, respectively, of its net revenues from sales of its transaction processing OCR and bar code products. The market for both of these sets of products is relatively mature and may not be subject to growth or expansion by the Company in the future. There can be no assurance that Caere's hardware-based transaction processing products will continue to be a significant source of net revenues for the Company.
Possible Volatility of Caere Stock Price
The market prices for Caere's Common Stock have fluctuated widely in the past. The management of Caere believes that such fluctuations may have been caused by announcements of new products, quarterly fluctuations in the results of operations, and other factors including, but not limited to, changes in conditions of the personal computer industry in general. Stock markets have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of securities issued by Caere and other high technology companies, often for reasons unrelated to the operating performance of the specific companies. Caere anticipates that the market price for its Common Stock may continue to be volatile. Such future stock price volatility for Caere Common Stock may provoke the initiation of securities litigation, which may divert substantial management resources and have an adverse effect on Caere and its results of operations.
Effect of Antitakeover Provisions of Delaware Law and Caere's Charter Documents
Caere is a corporation organized under the laws of the state of Delaware. Certain provisions of the Delaware Law and the charter documents of Caere may have the effect of delaying, deferring or preventing changes in control or management of Caere. Caere is subject to the provisions of Section 203 of the Delaware Law, which has the effect of restricting changes in control of a company. In addition, Caere's Board of Directors is divided into three separate classes. In addition, Caere's Board has the authority to issue up to 2,000,000 shares of Preferred Stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of such shares without any further vote or action by its stockholders. Caere also has a Preferred Share Purchase Rights Plan. The antitakeover protections of Delaware Law, the Caere charter documents, and the Preferred Share Purchase Rights Plan could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, a majority of the outstanding stock of the Company.
ITEM 2.

ITEM 2. PROPERTIES.
The Company's principal administrative, marketing, manufacturing, and product development facilities consist of approximately 56,000 square feet in two buildings in Los Gatos, California. The Company occupies this space under a lease agreement that expires in 2002. In addition, the Company leases office and storage space in four locations in the United States for use by its regional field sales and support staff. Caere GmbH also leases office space in Munich, Germany, for its operations, while Recognita leases office space in Budapest, Hungary. The Company believes that its existing facilities are adequate for its needs for at least the next twelve months.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in certain claims arising in the normal course of business. The extent to which these matters will be pursued by the claimants or the eventual outcome is not presently determinable. However, Company management, after review and consultation with the Company's counsel, believes that the ultimate resolution of these matters will not have a material adverse effect on its consolidated financial position or results of operations.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Incorporated by reference to the section of the Company's 1996 Annual Report to Stockholders entitled "Quarterly Results of Operations," page 31.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA.
Incorporated by reference to the section of the Company's 1996 Annual Report to Stockholders entitled "Financial Highlights," on the inside front cover.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Incorporated by reference to the section of the Company's 1996 Annual Report to Stockholders entitled "Management's Discussion and Analysis," pages 12 through 17.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Incorporated by reference to the sections of the Company's 1996 Annual Report to Stockholders entitled "Financial Statements," pages 18 through 32.
Supplementary data for the year ending December 31, 1995, is as follows:
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Incorporated by reference to the sections of the Company's definitive proxy statement for the 1997 Annual Meeting of Stockholders to be held May 13, 1997, entitled "Election of Director" and "Management."
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION.
Incorporated by reference to the sections of the Company's definitive proxy statement for the 1997 Annual Meeting of Stockholders entitled "Executive Compensation" and "Compensation of Directors."
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Incorporated by reference to the section of the Company's definitive proxy statement for the 1997 Annual Meeting of Stockholders entitled "Security Ownership of Management and Principal Stockholders."
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated by reference to the section of the Company's definitive proxy statement for the 1997 Annual Meeting of Stockholders entitled "Executive Compensation," "Compensation of Directors," "Stock Option Grants and Exercises," and "Certain Transactions."
PART IV
ITEM 14.

ITEM 14. BITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) 1. INDEX TO FINANCIAL STATEMENTS
The following documents are incorporated in Part II of this Annual Report by reference to the 1996 Annual Report to Stockholders:
With the exception of the information expressly incorporated by reference into Items 5, 6, 7, and 8 of this Annual Report, the 1996 Annual Report to Stockholders, attached as Exhibit 13.1, is not deemed filed as part of this report.
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule is filed as a part of this Annual Report and should be read in conjunction with the Financial Statements:
Schedule II -- Valuation and Qualifying Accounts
All other schedules are omitted because they are not required, or not applicable, or because the required information is included in the 1996 Annual Report to Stockholders, filed as Exhibit 13.1.
3. EXHIBITS
- ---------------
* Management contract or compensatory plan or arrangement.
(1) Incorporated by reference to the corresponding or indicated exhibit to the Company's Registration Statement on Form S-1, as amended (File No. 33-30842).
(2) Incorporated by reference to the indicated exhibit in the Company's Form 8-K Current Report filed on April 18, 1991.
(3) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1991.
(4) Incorporated by reference to Caere's Registration Statement on Form S-4 (File No. 33-85840).
(5) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1994.
(6) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1995.
(B) REPORTS ON FORM 8-K.
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CAERE CORPORATION
Dated: March 25, 1997 By: /s/ BLANCHE M. SUTTER ------------------------------------ Blanche M. Sutter Executive Vice President, Chief Financial Officer and Secretary
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert G. Teresi and Blanche M. Sutter, or either of them, his attorney in fact, each with the power of substitution, for him or her, in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys in fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEPENDENT AUDITOR'S REPORT
The Board of Directors Caere Corporation:
Under date of January 28, 1997, we reported on the consolidated balance sheets of Caere Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996, incorporated by reference in the annual report on Form 10-K for the year ended December 31, 1996. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule in the Form 10-K as listed in the index under Item 14(a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
San Jose, California January 28, 1997
SCHEDULE II
CAERE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1996 (IN THOUSANDS)
CAERE CORPORATION
INDEX OF EXHIBITS
- ---------------
* Management contract or compensatory plan or arrangement.
(1) Incorporated by reference to the corresponding or indicated exhibit to the Company's Registration Statement on Form S-1, as amended (File No. 33-30842).
(2) Incorporated by reference to the indicated exhibit in the Company's Form 8-K Current Report filed on April 18, 1991.
(3) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1991.
(4) Incorporated by reference to Caere's Registration Statement on Form S-4 (File No. 33-85840).
(5) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1994.
(6) Incorporated by reference to the corresponding or indicated exhibit to the Company's Form 10-K Annual Report for the fiscal year ended December 31, 1995.