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Nuance Communications, Inc. (NASDAQ:NUAN)

Q1 2020 Earnings Call

February 8, 2010 5:00 pm ET

Executives

Paul Ricci – Chairman of the Board, Chief Executive Officer

Thomas Beaudoin – Chief Financial Officer, Executive Vice President

Analysts

Daniel Ives – FBR Capital Markets

Jeff Van Rhee – Craig-Hallum Capital

Richard Davis – Needham & Company

Shyam Patil – Raymond James

Abhey Lamba – ISI Group

[Brent Phil – UBS]

John Bright – Avondale Partners

Michael Latimore – Northland Securities

Craig Nankervis – First Analysis

Bradley Whitt – Broadpoint Capital

Mark Murphy – Piper Jaffray

Scott Sutherland – Wedbush Morgan Securities

Gonzales for Derek Bingham – Goldman Sachs

Jeff Rath – Canaccord Adams

Operator

Welcome to Nuance’s first quarter 2010 conference call. (Operator Instructions) With us today are Chairman and Chief Executive Officer of Nuance, Mr. Paul Ricci and CFO Mr. Tom Beaudoin. At this time I would like to turn the conference over to Mr. Ricci.

Paul Ricci

Thank you. Before we begin, I remind everyone that matters we discuss this afternoon include predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to our recent SEC filings for a detailed list of risk factors.

As noted in our press release, we issued along with our release a set of prepared remarks in advance of this call. Those remarks are intended to serve in place of extended formal comments and we will note repeat them here.

Before taking your questions though, I might underscore one point from our release and remarks. We were especially pleased with the strength of the company’s performance in the first quarter was quite broad based across business lines and geographical markets. You will note from our prepared remarks in particular, the resumption of appreciable organic growth in all three reported revenue categories.

As our comments made clear, we anticipate the continuation of growth during this fiscal year. Improving trends in royalty reports, expansion of our on-demand revenues from new customers won during the last year, contributions from new mobile services, especially voice mail to text, and renewed capital purchasing in large enterprises are all factors enabling this growth.

Last quarter I used these brief comments to reiterate our conviction in the fundamental attractiveness of our markets and our position in those markets. The improved results across our diverse business lines increases our conviction both about the opportunities and about our advantage position and to seize them.

I will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Ives – FBR Capital Markets.

Daniel Ives – FBR Capital Markets

Great job in growth come back. Talk about health care in terms of deal sizes. Are you seeing bigger deal sizes and maybe talk about the sales efforts on there, how successful you are with hiring some of the people on the street.

Paul Ricci

I’ll begin at the end and work backwards on your question. We had a concerted effort during the quarter to fill a large number of open positions in our health care sales team and we completed nearly all the recruitment we had targeted for the first quarter. We have targeted additional expansion in our sales team for this quarter but generally speaking our ability to hire has been quite good.

The overall trend in our on-demand business in health care has been towards larger deals. That continues to be true. We had a particularly large contract that was signed actually just after the quarter ended.

In our on-premise sales, I think that there has been no change in the size from previous quarters. We’re not seeing and change in the trend there.

Daniel Ives – FBR Capital Markets

Talk about on the enterprise within North America. How do you expect that to play out during the year in terms of recovery and how are we going to see it flow into the model?

Paul Ricci

There are several trends going on in the enterprise business. Most revolve around the increased presence of our own direct sales force and the representation of our solutions in large enterprises here and internationally.

As we’ve discussed in previous quarters, we have particularly benefited from success in expanding our on-demand enterprise business and that continues to be true. We have a lot of activity there. Those tend to be long lead time sales and they tend to be substantial in size and I think we’ll have some success this quarter at closing one or two substantial deals that will further that growth, but we will already this year, particularly in the third and fourth quarters see contributions from previously won business in our on-demand.

Elsewhere we did see improvements overall in our enterprise business particularly in North America this quarter. We’re seeing some improvements in our revenues from our royalties from our channel partners, but more importantly, we’re just seeing improved attitudes towards capital purchases and solutions in that segment generally.

Operator

Your next question comes from Jeff Van Rhee – Craig-Hallum Capital.

Jeff Van Rhee – Craig-Hallum Capital

Kind of an open ended but high level question; a number of places in the script here you comment to the effect of the shift to the on-demand and as I read through it I guess it’s just unclear to me in general where you’re seeing surprises in terms of the move to the on-demand model in terms of it being more of a shift than expected or less of a shift. Can you just comment at the margin whether or not you’re seeing more demand than you expected three months ago or how that’s trending?

Paul Ricci

I wouldn’t say we’re seeing more than we expected three months ago and we didn’t mean to convey a sense of surprise. We substantially repeated comments in the prepared remarks this quarter that we made quarter simply to reemphasize that this is a secular shift going on that the increased interest, the heightened interest among our largest customers both in health care and enterprise for on-demand is not an episodic activity but it’s something that’s a trend that we expect to continue.

I don’t think there’s been a particular variation in that trend from previous quarters. So I wouldn’t have conveyed it as a surprise really.

Jeff Van Rhee – Craig-Hallum Capital

Are you willing to give us at least a snapshot maybe of the size of the on-demand business at this point?

Paul Ricci

We don’t publish that number separately. I can simply say that it’s part of the services and hosting and I don’t think we give a separate number. I don’t think we’ve done that in the past so I probably shouldn’t start today.

Jeff Van Rhee – Craig-Hallum Capital

The linearity for the year, there were a couple of points in the outlook that revenues would be skewed toward the back half of the year and you certainly mentioned that to some degree before. As you sit here having just put up some real nice revenue upside on this quarter and you look at the remainder of the year in terms of linearity of quarters, any surprises?

Paul Ricci

I don’t think there are any surprises or irregularities from what we suggested last quarter. We did have a strong first quarter and we’re optimistic that that momentum will continue, but no surprises really.

Operator

Your next question comes from Richard Davis – Needham & Company.

Richard Davis – Needham & Company

As you get more towards an on-demand solution and it continues to grow rapidly how do you look at your capital spending because some people have to do it themselves, some people push it out on various public clouds and you can access it that way, but if you could talk about that it looks like CapEx is running at $10 million to $12 million on an annualized basis. Does that number gradually pick up and if so how much over time, over the next few years?

Paul Ricci

I might make a couple of comments. First, I want to reemphasize from the last question that our view of on-demand is that it is a secular trend that’s going to be a continuous evolution and not a heightened one in any particular respect. In fact, we had quite a strong licensing quarter in the fourth quarter of on-premise licensing; excuse me in the first quarter.

With respect to capital, the infrastructure capital is a continuous investment but its one that we’ve been making for quite some time now and the cost of capital investment for hosted solutions has of course enjoyed enormous price benefits to us and others over the last couple of years. We expect that to continue.

I don’t think that that particular element of the capital is going to be at all discontinuous with what we’ve done. There is a bit of a challenge however, in that there is a significant investment in services in building solutions particularly in the enterprise space for these on-demand customers and we typically have to take that expense upon ourselves and then realize the benefits in the transactional pricing that we get over a series of year.

So there is some capital consumed there, and we’ve built that into our plans. But that is a consumption of capital up front for longer term cash returns in those deals.

Operator

Your next question comes from Shyam Patil – Raymond James.

Shyam Patil – Raymond James

Could you talk a little bit about what kind of license growth or percent of revenue you’re contemplating in the 2010 guidance?

Paul Ricci

I don’t have that number at my fingertips. Let’s see what we can come with while we’re on the phone. Do you have any other questions?

Shyam Patil – Raymond James

Looking at the unimplemented backlog for the on-demand contract, it looks like that declined about $30 million sequentially. Have you recognized that $30 million and if not how much of that is still in the unrecognized revenue bucket or backlog that you expect over the next 12 to 18 months.

Paul Ricci

Almost all of it is unrecognized. The metric we chose was to take the expected forward value of all the unimplemented contracts and to count them, to sum them, and when the implementation is complete and recognition begins, it’s moved out of the unimplemented category.

So in particular, in the end of this last quarter one deal that has a forward value of perhaps $25 million or so was moved from unimplemented to implemented because we actually had brought the application up and were running it for the customer for whom we built it.

So there will some lumpiness to that metric as we sign these deals. They’re pretty large deals and we expect one or two large deals a quarter but there will be a certain lumpiness in it.

Shyam Patil – Raymond James

Around the professional services gross margins for the balance of the year, how should we think about that trending for the next few quarters?

Paul Ricci

I think you should assume that the professional services margins will remain at about where they are today.

We don’t provide growth numbers by sub category revenue so I don’t think, or projections rather, so I don’t think I have anything to offer you on your first question.

Operator

Your next question comes from Abhey Lamba – ISI Group.

Abhey Lamba – ISI Group

Can you talk about sales hiring cushion? Should it continue throughout the year or are you expecting it to slow down in the second half. Also, what’s the time lag for these new reps to be fully productive?

Paul Ricci

Our plan calls for us to hire our sales personnel primarily in the first half of the year. I think we will be successful in achieving our head count goals in the first half of the year. We’ll have to stop and look at that point as to whether the momentum in the business argues for continuing that hiring trend in the second half. It’s not in our current plan and we’ll just have to see how the overall picture and performance is looking at that point.

It’s a little difficult to say much generally about productivity for sales personnel because we’re hiring them in several different places in the business and the ramp up time is considerably different for example for a new sales staff in the health care business in North America or a mobile sales personnel in Asia; very different time lines. So I don’t think I can give you a particularly valuable average number there.

Abhey Lamba – ISI Group

Which area are you hiring more in terms of project segments? Can you elaborate on that?

Paul Ricci

As we had indicated last time, we had significant hiring in our health care business in North America, but also in Europe. We had some hiring in our enterprise business primarily in North America and significant expansion of our sales personnel in some of the more rapidly growing economies, particularly Asia, Eastern Europe, some staffing in Latin America.

Abhey Lamba – ISI Group

Can you talk a little bit about how the competition is in each of your segments and do you see Google in any of your target markets?

Paul Ricci

We have different competition in each of our markets and there hasn’t been any market change in that competitive landscape for the most part. It is the case that Google has launched a number of voice enabled initiatives in the mobile business. They have a somewhat different approach to the market than we do so we tend to be working with carriers and device manufacturers enabling solutions through their devices and through their networks so I think they view us as a complementary provider of services that they might see as being competitive with Google.

Operator

Your next question comes from [Brent Phil – UBS]

[Brent Phil – UBS]

On the margin side, there’s only a handful of [inaudible] coming in above you where you’re operating margins currently sit and you’ve done a really nice job over the last few years getting some really good margin expansion. I’m curious in terms of how you think about is there a natural ceiling that will start to settle in here on where you think the margins can go. When I think back to your remark about the on-demand business, I would assume the on-demand business as you move there that is potentially going to be even higher margin than the current business. I was wondering if you comment on both.

Paul Ricci

With respect to the margin, I’m sure there is a natural ceiling but I think we’re well short of that ceiling. We continue to see many productivity opportunities in the business but those opportunities will take time, years in some cases to implement so we see continued opportunity for progress in margins this year, next year and the following year.

I have said in the last couple of quarters and I would want to emphasize again however, that right now what’s most on our mind is the need to seize the growth opportunities in front of us and therefore we’ve been very focused this year on investing in pursuit of those opportunities and investing in particular in additional sales personnel as I just mentioned, significant investments in engineering and research in pursuit of the markets, especially opportunities in the mobile markets and in advertising in support of our business.

So we’ve had some discussion in recent conference call I think about asking investors not to expect the same kind of margin expansion this year that we had last year, but we will continue to make progress with time.

With respect to your other question about on-demand, the gross margins are of course higher than services but not as high as pure licensing deals. The sales costs in our hosted on-demand business though seems to be significantly lower than our other businesses so I do think the growth of on-demand will contribute to our margin growth over the years.

[Brent Phil – UBS]

On accounts payable, I think it was up to $83 million sequentially, was there a reason for that big a jump?

Thomas Beaudoin

Most of that was associated with the SpinBox acquisition so I think it was about $84 million, about $70 million of that was associated with SpinBox. And then there was a little bit of employee accretive cost that went in that.

Operator

Your next question comes from John Bright – Avondale Partners.

John Bright – Avondale Partners

Organic growth reaccelerated in the quarter. Is that pent up demand? Is it sustainable? Should we expect that to continue throughout the remaining portion of the year? And along those lines, reconcile for me your confidence in the capital spending markets as associated with the on-premise business. At the same time we’re seeing some good results on the hosted side.

Paul Ricci

With respect to the first question, I don’t think I would describe it as pent up demand. There may be some of that in particular in the on-premise enterprise business. There may be some pent up. But as the prepared remarks suggest and as my brief comments at the beginning of this call attempted to reiterate, the improvement in the business is really quite broad based across all of our markets and our geographies.

We think it represents improved macro economic situation, improved execution and a heightened interest in a couple of our markets for speak solutions, particularly in the health care and the mobile markets.

With regard to your second question, we’ve always believed that there would be a mixture of large IQ organizations that wanted to do on-premise solutions and those that were moving to more of an on-demand and hosted solution. We continue to believe that’s true and while there has been, as I’ve indicated a couple of times on this call, and continues to be a secular shift towards the on-demand, there are still a large number of our customers who have a clear preference for implementing on-premise and we’re eager to serve them in both ways.

We’ve had some sales where we’ve been the chosen vendor but they’ve oscillated in their decision about whether to go on-premise or to have it hosted, and I think part of our selling proposition is the ability to serve them both ways.

John Bright – Avondale Partners

So let me take those in reverse order. On the CapEx versus the hosted business, what inning are we now this quarter, your best guess? What inning of this transition?

Paul Ricci

I don’t know. I think we’re very early on in the long term migration to hosted and cloud based solutions, very early on.

John Bright – Avondale Partners

Back to the organic growth, it looks like while they all three performed well, health care dictation was around 6%, but that’s the one that you expect to be the leading grower in 2010, is that correct?

Paul Ricci

I did say at the beginning, at this time in our last quarter call, I did say that I thought health care would be the leading growth business line in our mix this year. That turned out not to be true in the first quarter. I don’t view that as a challenge in the health care business, but rather the reflection of significant improvement of results in the other markets. So we’re delighted by that.

Operator

Your next question comes from Michael Latimore – Northland Securities.

Michael Latimore – Northland Securities

On the health care business, you reported a number of lines transcribed on an annualized basis and it looks like the growth rate is about 19% in the quarter and last quarter it was 31% year over year. Any color on why the change in year over year growth rate there?

Paul Ricci

There is some seasonality and fluctuation in the actual usage of the systems but nothing additional. I don’t think there is any particular trend at work there

Michael Latimore – Northland Securities

Is it fair to think of that business as kind of line growth to be closer to the teen’s percent or 30% going forward?

Paul Ricci

I don’t predict growth of business lines at that level of granularity so I don’t want to comment on that. It’s historically been a rapid growth item for us and the historical growth has been closer to the higher percentage than the lower percentage, but we’ll have to see how that plays out over the next year.

Michael Latimore – Northland Securities

On the operating margins by business segment, I know you don’t report that, but if you were to take the mobile enterprise, health, imaging, have there been any change in which one has the highest margin versus the lowest margin over the last year or so?

Paul Ricci

One thing I could say is that the variation among them has declined over the last 12 to 18 months. Enterprise margins have gotten better and the other margins have come down a little as we’ve increased investments to seize future growth. But that’s been a relatively continuous change and not anything dramatic.

Michael Latimore – Northland Securities

On digital imaging, you had a number of new product releases in your fiscal 2009. Are there any new product releases you’ve planned for this year or are your comments around strengthening that business, do you see continued growth in the non E portion of your digital imaging business despite no new product releases or fewer this year?

Paul Ricci

We think that the set of releases we did late in the last fiscal year position us well for the coming year. I believe there is one more release this year but I don’t know the date of that specifically.

The answer to your broader question is yes, we expect that part of the business to achieve growth this year based on those releases.

Operator

Your next question comes from Craig Nankervis – First Analysis.

Craig Nankervis – First Analysis

I wonder if you could talk a little bit about gross margin which I believe was at I believe was at a six or seven quarter high. You referred in the text of your remarks to mainly a mixture of results but I would like to understand if there is perhaps something sustainable here that would take gross margin on average as we move through the quarters for the rest of the year up from where we’ve been seeing it more recently.

Paul Ricci

I don’t think you should assume any significant change in gross margins. There are a lot of factors at work in our gross margins. There is a mix factor and there is an overall productivity gain and there are some particular elements that have influenced the last couple of quarters including the accelerated sales this quarter of our Dragon consumer product which has somewhat lower margins.

But I would tend to look at the gross margin as being a continuation of what you’ve seen for the last couple of quarters.

Craig Nankervis – First Analysis

Touching on SpinBox, can you discuss at some level why we should be too nervous about the integration of this asset just given the state of affairs with that company and maybe how many quarters from now would you fell like you’ve got the integration well in hand or under control or good visibility into it? Could you talk about that a bit?

Paul Ricci

Let me answer the question by first pointing out that we’ve done over 30 acquisitions in the last eight or nine years and we’ve bought companies ranging from very successful, highly profitable businesses to businesses that we’ve acquired out of bankruptcy and we think we have a lot of experience in buying assets including troubled assets, recognizing the core value of those assets and stripping away the problems.

We looked long and hard at SpinBox. We believed we knew going into it what had to be done. We’ve had the most intensive team working on it that we’ve probably ever applied to an acquisition.

The integration activities are underway. The realization of the synergies is moving in place. We expect to have significant aspects of the integration done by the end of this fiscal quarter. So I think I have to tell you that there is a core business there, a core market that is very attractive.

There is the ability to apply Nuance’s technology and achieve productivity gains. There is visibility to fold the operation into Nuance and achieve significant cost reductions and synergies that way. And, there is a very experienced and disciplined team working on doing it with incredible speed.

Craig Nankervis – First Analysis

If we look at mobile from a higher level, how would you rank the top two or three growth drivers for the mobile business as you look out over the next 12 to 18 months? What do you see in particular in the relative near term as the most exciting drivers.

Paul Ricci

I would point first to the mobile service realm of voice mail to text which is going to be a very fast growing revenue stream for us for the next couple of year I believe. Secondly, we are enjoying the benefits of enhanced royalties from the resumption of purchasing in consumer electronics, and from the recovery of the automotive market where we have a terrific presence.

And finally, we’ve mentioned previously and I would mention again, Nuance mobile care which is the intersection of the mobile business with the broader market for enterprise customer care which we’re very enthusiastic about over time.

Craig Nankervis – First Analysis

On the auto side, does your enhanced participation in the same offering before, does that somehow do something broader for Nuance’s mobile play? I don’t know if for example you’re getting more of a royalty from the Ford deal or not, but does that do other things for you as we look out on the auto landscape?

Paul Ricci

As you would expect I can’t discuss the economics of the Ford deal itself. But what I would say is that the Ford announcement by Ford at CES got remarkable attention as it deserved. It’s a terrific solution that Ford has implemented and we think that has only contributed to the interest among automotive manufacturers world wide in accelerating the deployment of solutions like that.

And, I do think also related to that has been increased interest in the connectivity of the speed solution to information services that are available to a driver while in the car, and that of course is important strategically for us in the medium term in our mobile business.

Operator

Your next question comes from Bradley Whitt – Broadpoint Capital.

Bradley Whitt – Broadpoint Capital

Just looking at the professional services and hosting revenue line item, that has decline two quarters in a row. I just wondered if we could get any more color on that and what the expectations are going forward.

Paul Ricci

There are two factors there. The most important one is one that I referenced as part of an answer to an earlier question, and that is that we’ve had to invest significant professional services resources in our large hosted deals and we don’t recognize those as services revenues in the quarters they’re deployed. Those costs are accrued and realized in the transactional pricing of the on-demand deals.

That’s been an important factor as we’ve deployed significant resources towards a couple of very large enterprise deals that we’ve referenced in previous conference calls.

The second factor was just a seasonality factor. We tend to have a lot of employees in the December quarter who take unused vacations before the end of the calendar year which they must in order not to lose them. I think those are the two factors at play.

I would note to you that our backlog in professional services continues to grow and I think we’re hiring to try to enable the realization of that backlog more quickly.

Bradley Whitt – Broadpoint Capital

Concerning voice mail to text, who do you see from a competitive standpoint for that particular niche? And also, how should we think about the total addressable market for you from a revenue standpoint. You mentioned I think a billion voice mails in your press release. How do we get our arms around what that means in revenue to Nuance?

Paul Ricci

There are a number of competitors around the world. Most of them tend to be focused on one market, one geographical market or another and there are probably too many to list here. I don’t think anyone has Nuance’s capabilities for projecting a solution on a global basis and I think our operational capabilities and our technological strength are going to privilege us in most of these markets.

I’m not going to try to give you a specific available market. We are going to talk in the coming quarters to investors about our vision for mobile services which is I think is an expansive one, and we’ll use that opportunity to be somewhat clearer about the market sizes.

But I will emphasize our view about voice mail to text is it’s a very significant mobile service and probably among the most attractive revenue opportunities of scale available to us in mobility right now.

Operator

Your next question comes from Mark Murphy – Piper Jaffray.

Mark Murphy – Piper Jaffray

Regarding the sequential change in deferred revenue on the balance sheet, I’m wondering if you could possibly estimate how much of that was in FX effect and how much of that was SpinBox? It’s not clear to me whether SpinBox would carry a material amount of deferred revenue or not.

Thomas Beaudoin

The deferred revenues in total, short term and long term are up about $11 million. A very minor amount of that was SpinBox. Most of it was in our other businesses. FX has a very, very inconsequential impact.

Mark Murphy – Piper Jaffray

Another question on SpinBox, how are you looking at the allegations that are out there that SpinBox under the hood was really primarily offshore human transcription rather than a technology solution? I’m wondering if that now you own the business and have taken a closer look at it, is that effectively an untrue allegation or is that partially true and that’s really the opportunity here is to layer on the Nuance recognition engine.

Paul Ricci

There was a lot of press about SpinBox before we acquired them and I’m not going to try to speak to that flurry of press comments at all. What I can say is this, SpinBox currently uses a combination of technology and editing labor in the deployment of their solutions and their view was that the customers and markets they were serving required that combination to achieve the combination of cost and quality they had contracted for.

Our view is that there is going to be a mixture of services that are provided to carriers and enterprises that will include a range of automation depending upon the particular requirement of the customers and we’re prepared to offer everything from complete automation to partial automation as the customer requires.

We’ve always been completely transparent about which we’re doing for which customers so I don’t thing there needs to be any mystery about that. I will say that one of the early synergies that will occur with SpinBox is the introduction of our core technologies into their solutions which I think will improve quality and reduce cost for existing customers.

Mark Murphy – Piper Jaffray

When you net out the SpinBox transaction, are you expecting that to be either accretive or dilutive in the course of this fiscal year?

Paul Ricci

We’re expecting it to be roughly neutral for the balance of the year.

Mark Murphy – Piper Jaffray

Did you make an adjustment to the organic revenue growth rates from the September quarter?

Paul Ricci

No, we did not other than our normal calculation of organic growth there were no other changes. And just to restate that, what we always do is assume that we own the company for that comparable period.

Mark Murphy – Piper Jaffray

I’m looking at the imaging organic growth. If we go back three months it was 24% and I’m seeing that now at 16%. I’m not sure if I’m looking at that correctly.

Paul Ricci

I think you’re looking at reported versus organic.

Thomas Beaudoin

He’s looking at the organic table and all the organic tables are updated because of the acquisition.

Mark Murphy – Piper Jaffray

So I think there is an impact there because of some of the new products that had an impact on that business.

Paul Ricci

Just to remind you, whenever we make an acquisition we have to include it in the organic tables as if we had owned it for the full year before the first quarter in which its present, and I think therefore the inclusion of the e-copy acquisition changes the organic calculation as a result.

Mark Murphy – Piper Jaffray

At a high level, any thoughts on how cash flow should trend this year?

Paul Ricci

We’ve just not provided forward-looking cash flow projections in the past other than the general comments that cash flow should track the increases in pro forma net income and that we expect to see continued improvements in cash flow year to year.

Operator

Your next question comes from Scott Sutherland – Wedbush Morgan Securities.

Scott Sutherland – Wedbush Morgan Securities

On that last question on your cash flow to follow up, I think in the past there was a goal to have it mirror pro forma net income. Is that still kind of a long term goal of the business here and is there any puts and takes in the quarter that it was a little bit softer?

Paul Ricci

No, it is our long term goal. There are a couple of factors in this quarter. One is the change in accounting which led to the inclusion of merger and acquisition expenses, transactional expenses in cash flows.

The other is just a difference in working capital as compared with what was a very favorable working capital improvement in the year prior.

Scott Sutherland – Wedbush Morgan Securities

Another question on SpinBox; I know you’ve been asked a lot about it. Is this mostly going to be in the services hosting revenue and if so, is there going to be any impact on the margins in the near term that we should think about or is it negligible?

Paul Ricci

It will almost entirely be in hosting and services. There may be some impact in the first couple of quarters but I don’t think there will be a significant long term impact.

Scott Sutherland – Wedbush Morgan Securities

In the mobile, in your comments you talk about an increased royalties and you also mentioned some better demand in consumer electronics so it definitely sounds like unit volumes are starting to increase. First I want to know if that is true and secondly have you seen any change in the pricing environment there? And what is the tax rate assumptions for this year?

Paul Ricci

With respect to the mobile business, it is indeed the case that our royalty reports are reflecting broadly improved purchasing by end users of our customer’s products both in consumer electronics and automobiles.

I wouldn’t say there’s been any market change in the pricing in that business since we talked last quarter.

Thomas Beaudoin

The tax, we had a little of favorability in Q1 based on a couple of state and local tax credits and settlements we were able to gain. The tax rate as you know, we’re only paying foreign, U.S. and state tax pretty much for the rest of the year and that should be in the $4 million to $6 million range per quarter over the next three quarters which is about what it would have been in Q1 other than the credits that we were able to secure.

Operator

Your next question comes from Gonzales for Derek Bingham – Goldman Sachs.

Gonzales for Derek Bingham – Goldman Sachs

A quick question on earn outs. Is there any updates? It sounds like SpinBox is going pretty well. Are there any big earn outs coming up in the next quarter or two?

Thomas Beaudoin

There are no earn outs from the SpinBox acquisition.

Gonzales for Derek Bingham – Goldman Sachs

Or any copy or any others we should be thinking about?

Thomas Beaudoin

There is an earn out associated with one of our mobile acquisitions of a year ago and I think that’s coming up in the coming quarter.

Gonzales for Derek Bingham – Goldman Sachs

Any color or is it non material?

Thomas Beaudoin

I don’t have anything to add to that since we haven’t done the analysis on that yet.

Gonzales for Derek Bingham – Goldman Sachs

Is pricing pressure, is that affecting you in terms of lower ASP’s? Is that affecting your business in terms of pricing pressure?

Paul Ricci

As I said in an earlier question, the mobile business as we’ve commented in previous conference calls has always been a very price sensitive business. It will continue to be a price sensitive business, but I haven’t seen any changes in that in the last few months.

Gonzales for Derek Bingham – Goldman Sachs

In terms of head count numbers, did you state anything on the call in terms of what it was this quarter and for the rest of the year?

Thomas Beaudoin

At the end of the quarter we were at 3,284. We don’t forecast head count going up for future quarters and that was off about 128 quarter over quarter which was mostly acquisition related. As Paul said, we hired sales people but we also continued to drive productivity and efficiency so this quarter they pretty much offset.

Gonzales for Derek Bingham – Goldman Sachs

And in terms of SpinBox, are you finishing rationalization this quarter in terms of head count do you think?

Paul Ricci

I don’t want to say we’re finishing this quarter. What I said earlier is we’re moving very quickly and there will be significant implementation actions over the coming months, but acquisitions always take some time to complete the rationalization of and I don’t want to give you a false sense that it will be done at the end of this quarter.

Operator

Your next question comes from Jeff Rath – Canaccord Adams.

Jeff Rath – Canaccord Adams

I wanted to ask a couple of M&A related questions. First of all can you characterize your deal pipeline that you see right now? Has it changed in an improving economic environment and does your view around your appetite given the resumption of organic growth, does that change at all? Any color would be helpful.

Paul Ricci

Nuance has always been quite active in evaluating potential acquisitions and that remains true. I think generally speaking, the pace at which we do acquisitions other than very small acquisitions has slowed somewhat in the last couple of years. I don’t have any immediate reason to think that’s going to change.

We remain interested in acquisitions but we’re careful buyers and there is enough change in asset prices going on in the market that it’s not necessarily that easy to come to closure between buyer and seller on what a fair price is, so we remain cautious about that.

I don’t think that factor is influenced by the improvement in organic growth.

Jeff Rath – Canaccord Adams

More of a philosophical question, as your company is well past the billion dollar revenue mark; your law of large numbers comes to play here as you look at long term revenue growth trends. How do you think about philosophically managing the balance between revenue growth and managing that as best you can and then also managing your share count? I guess the underlying premise here is your growth has obviously been slowing over time as you get to a larger company. I’m just wondering when you think about things like stock based compensation and the use of earn outs and stock in acquisitions, how do you manage those two elements or how do you think about those two elements when you think about the broad road map for Nuance?

Paul Ricci

We have in the past used a combination of cash and stock to make acquisitions. We’ve tended somewhat to use more cash in the last year and a half because of the turbulence in the stock market and the fluctuations in our equity price. We have considerable cash flow generation and so we have the ability to do small to medium sized acquisitions using cash.

We certainly have set a high bar for use of stock and acquisitions. It has to be financially compelling and attractive and accretive deal for shareholders and I think that’s been true for some time and won’t be changed materially by the growth of the company.

Jeff Rath – Canaccord Adams

I guess the second element of that is just as you think about stock based compensation ratios going forward, is there a rule of thumb that you’re working towards as it related to ongoing dilution here just as part of the natural course of compensation?

Paul Ricci

It’s a proportion of the overall equity. Our stock based compensation I think has come down over the last couple of years. I don’t know if there’s going to be any particular change in that trend from last year to next year or the year after though.

Operator

There are no further questions.

Paul Ricci

We thank you again for joining us and we look forward to speaking to you again at the end of next quarter.

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Source: Nuance Communications, Inc. Q1 2010 Earnings Call Transcript
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