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Executives

Paul Ricci – Chairman and CEO

Tom Beaudoin – EVP and CFO

Analysts

Daniel Ives – FBR

Nandan Amladi – Deutsche Bank

Shyam Patil – Raymond James & Associates

John Byrne [ph] – UBS

Derek Bingham – Goldman Sachs

Jeff Van Rhee – Craig-Hallum

John Bright – Avondale Partners

Scott Sutherland – Wedbush Securities

Ilya Grozovsky – Morgan Joseph

Brad Whitt – Gleacher & Company

Mike Latimore – Northland Capital Markets

Mark Murphy – Piper Jaffray

Craig Nankervis – First Analysis

Tom Roderick – Stifel Nicolaus

Nuance Communications, Inc. (NUAN) F3Q10 (06/30/10) Earnings Call Transcript August 9, 2010 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Nuance's third quarter 2010 conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions) As a reminder, this conference is being recorded. With us today are the Chairman and Chief Executive Officer of Nuance, Mr. Paul Ricci; and CFO, Mr. Tom Beaudoin. At this time, I would like to turn the call over to Mr. Ricci. Please go ahead, sir.

Paul Ricci

Thank you. Before we begin, I’d 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 not repeat them here.

Before taking your questions, I might underscore that we are seeing growing strength in our bookings as evidenced by the supplementary backlog metrics we published today. In particular, I would note that we had a very strong bookings quarter in our enterprise on demand offerings. We anticipate strong bookings in Q4 as well, which we believe should provide momentum for revenue growth in FY ’11.

Additionally, Nuance’s healthcare business provided especially robust performance in the quarter, drawing upon strength across most of our healthcare products and service offerings. We believe we are uniquely positioned to serve the healthcare market with our leadership in quality, capabilities and cost.

Finally, I want to comment on the volume of opportunities in our mobile business as the reception to our solutions in mobile devices continues to grow. You can see some evidence of that in the range of activities cited in our prepared remarks. All of these factors give us increased confidence as we complete FY ’10 and look towards fiscal year ’11.

We will now take your questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Daniel Ives with FBR. Please go ahead. Your line is open.

Daniel Ives – FBR

Thanks. Few questions. So Paul, when you look at the revenue range that you gave, and obviously you came in on the low end. I know the FX issue. How can you kind of reconcile that range with the bookings performance? Was there – can you quantify a certain amount of revenue that you expected to come in the quarter that ultimately was off balance sheet?

Paul Ricci

The most germane area where the bookings performance diverges from revenue is in enterprise, and we talked about that before. We are seeing a growing increase in the demand for enterprise-hosted solutions as compared to on-premise solutions. As I’ve said in previous quarters, I think that trend is going to continue. And that will have an effect on elongating revenues as compared with bookings.

Daniel Ives – FBR

So, was that more than expected, that trend?

Paul Ricci

I think that there has been a continuation of that trend from previous quarters. There were several elements contributing to some weakness in our enterprise revenues in the quarter as compared to our backlog in bookings. And that included, again, a preference for our hosted solutions. Some ramping delays in our existing on-demand contracts that we’ve won over the last 18 months. And as we referenced in the prepared remarks, there is continued softness in our channels, which is increasingly of course being replaced by our own direct revenues and services.

Daniel Ives – FBR

Okay. And then just talk about cash flow, with those expectations in line, with your thoughts going into the quarter? And then how should we think about cash in Q4? I know you don’t guide, but just directionally.

Tom Beaudoin

Sure, Daniel. Cash flows, we diverge this quarter of about $27 million from non-GAAP net income. That was slightly less than last quarter. It’s predominantly in three areas. So, about $11 million of it was working capital. So, an increase in working capital. And we did see, for the first time this quarter, a couple of large customers who have historically paid us the last week of the quarter pushed payments by just a few days, and so that cash came in. That was about $7 million came in, in the first week of Q4. So about $11 million for working capital, about $11 million associated with SpinVox, and we continue to work through some of those acquired liabilities and the other impacts of CFFO from SpinVox. That should be probably about half of that or significantly improved as we go into Q4.

And then the last piece, which is just the restructuring and acquisition-related cost that was about $6 million this quarter. And that will continue, but will fluctuate based on acquisitions. You can see that line historically on the P&L if you look at the acquisition and restructuring-related costs. This quarter, there was just a very small amount associated with the non-GAAP revenue. So we are pretty much through the revenues that come through purchase accounting, for which there is no cash. And that should –borrowing any other services-type acquisitions would bring a lot of deferred revenues, and that impact on cash flow is pretty much behind us.

Daniel Ives – FBR

Okay, thanks.

Paul Ricci

Greg, we’re ready for our next question.

Operator

The next question comes from the line of Nandan Amladi with Deutsche Bank. Please go ahead.

Nandan Amladi – Deutsche Bank

Hi, good afternoon. Thanks for taking my question. You had a big jump in CapEx this quarter. Is that a – should we think of that as a leading indicator for the new business you’ve booked or was there some catch-ups from – that you were a little lower last quarter?

Paul Ricci

There will be a general increase in CapEx associated with our hosting businesses and other capital expenditure requirements. But I don’t think you should expect anything mark in that respect.

Nandan Amladi – Deutsche Bank

Okay. And then one more question if I might, your organic revenue that you’ve put in the exhibit for the mobile and enterprise segment was negative 1%. Which of the segments – you talked about strength in the enterprise. So, should we assume that it was the mobile segment that was a little bit slow in the quarter because it’s not a seasonally strong quarter for mobile?

Paul Ricci

Just to be clear, I may have been imprecise in my earlier comments. The bookings in enterprise were quite strong. The relative organic performance of enterprise was the lower of the two between enterprise and mobile in revenues. My point earlier was that we continue to see strong bookings and backlog in our enterprise business.

Nandan Amladi – Deutsche Bank

Okay. Thank you.

Operator

And next we turn to the line of Shyam Patil with Raymond James & Associates. Please go ahead.

Shyam Patil – Raymond James & Associates

Hi, good evening. Paul, it looks like the enterprise business, at least the underlying trends are pretty strong, but they are not being completely reflected in revenue. What metrics can we look at externally based on what you report to kind of validate the underlying strength if there are any? And when can we expect some more accurate metrics?

Paul Ricci

We tried to include some supplementary metrics in our prepared remarks that are designed to give you a bit more insight into the trends in our enterprise business. And as we commented earlier, those two metrics are both favorable this quarter and I expect that they will continue to show favorability as we go into next quarter and into fiscal ’11. Those metrics will ultimately of course have to play out in revenue growth. And we ought to see that start to happen in fiscal ’11, but it is going to take some time for the on-demand contracts to begin to show the kind of significant revenue growth that’s imbedded in those contracts, which as you know are very large contracts.

Shyam Patil – Raymond James & Associates

Okay. And then I have a couple questions on the cash flow. Tom, you talked about the accounting change and the M&A, legal and banker fees being included, and cash flow from operations this year. It looks like that runs around 5% to 10% of net income. So if we kind of assume that stays going forward, should we expect that at some point in 2011 that cash flow gets back to say 90% or so net income? And then also on that topic, how should we think about the SpinVox payments flowing? I know they are kind of spread out. I think there is one coming up in the December quarter. Could you just talk a little bit about how we should expect those payments to flow as well?

Tom Beaudoin

So the transition restructuring and acquisition, it’s historically been, as you say, about $5 million to $6 million a quarter. But it can fluctuate depending on acquisitions. The working capital, I think you can reasonably model just from a growth perspective around DSOs and DPO. That’s really the only thing impacting that. We do have some efficiencies we think we can continue to drive in that space, but they are not going to be very significant.

SpinVox is down to just a little bit of flow-through in Q4, as I talked about earlier. And then there is a couple of payments associated with some large contracts in FY ’11. You will see on the balance sheet that there is a line called restricted cash this quarter, and that’s associated with one of the payments that’s due in Q1 associated with those contracts. So I think that’s the biggest one left, and then there is a couple of smaller ones in the back half of next year.

Shyam Patil – Raymond James & Associates

Okay, thank you.

Operator

There is a question from the line of Brent Thill with UBS. Please go ahead.

John Byrne – UBS

Hi, this is John Byrne [ph] for Brent Thill. Going back to the other question regarding the non-GAAP revenue relative to the guidance range, was there maybe any deal that’s slipping maybe on a perpetual side? And also maybe if you could give like some color around the geography maybe that was either stronger or weaker?

Paul Ricci

Sorry, I just kind of have to ask you to repeat the question a bit more slowly, please.

John Byrne – UBS

Sure. Sorry. In terms of the actual revenue that came toward the lower end of the guidance range and in the various factors related to that, was any of that related to maybe some deals slipping, let’s say, on the enterprise rise maybe under perpetual license side? And also, was there maybe any additional color by geography in terms of strength or weakness?

Paul Ricci

With respect to the geographical question, performance was reasonably balanced across our geographies. So there is nothing in particular to call out there. With respect to your question about, were there perpetual licenses delayed, we have a large pipeline of deals in the enterprise business. Some of them perpetual, some of them are hosted recurring revenue streams. And in any given quarter, some number of them are on the list of possibilities to close and don’t for a variety of reasons. That’s certainly the case this quarter as well. So the quarter could have been affected positively by additional deals that might have closed, but that’s true every quarter.

John Byrne – UBS

And if I can ask one more question, on the Android, I mean, you had a pretty nice win on the T-Mobile side. And I’m wondering – how much correlation there is with the growing market share of the Android platform and your own revenues.

Paul Ricci

I can’t comment on revenues by phone platform. I can say that, in general, the smartphones are creating a lot of activity within our mobile business for incorporation of our solutions, and we expect to see relative outsize growth in the class of smartphones generally without talking about any specific operating system platform.

John Byrne – UBS

Okay. Thank you.

Operator

Next, we turn to the line of Derek Bingham with Goldman Sachs. Please go ahead.

Derek Bingham – Goldman Sachs

Hi, gentlemen. Paul, you had mentioned a little bit about some of the ratable shift happening on the enterprise side. On the mobile side, was there anything that disappointed you in the quarter that – or that didn’t come in as you would have liked?

Paul Ricci

There are always, again, some deals in the business that create revenues in the quarter that may or may not come in. There were a couple of mobiles that we thought would come in in the third quarter, but which fell into the fourth quarter. There is no significant trend there to report. There is of course an increasing number of deals in mobile that involve long-term revenue streams as well. And that is a shift going on in the mobile business as well.

Derek Bingham – Goldman Sachs

Okay. On the gross margins, the prepared remarks mentioned that you would see an improvement in professional services gross margins. Is that speaking to just the more kind of consulting implementation gross margins or is that speaking across the board, including the hosted revenues?

Paul Ricci

I believe the reference was to the increase in professional and hosted together. And you should think of that as improvements in the efficiencies in economies of delivering both of those services.

Derek Bingham – Goldman Sachs

I mean, can you characterize that a little bit in terms of what your expectation is going forward in that specific gross margin line on the services side, steady improvement or anything different on that?

Paul Ricci

Well, I think we do have additional opportunity for improvement. And that’s because some of the newer services that we are offering have relatively mature in terms of their cost management, as you expect, early in the life of a new service, particularly the mobile services. And I believe we will see over the course of the next year margins improve in those services.

Derek Bingham – Goldman Sachs

And OpEx, non-GAAP OpEx was down sequentially in June. You’re investing – can you reconcile those two things and kind of what your expectation is for R&D, sales and marketing and other OpEx lines going into the end of the year?

Paul Ricci

Just to be clear with your question, you’re pointing out that the percentage of revenues is down –?

Derek Bingham – Goldman Sachs

Well, in absolute dollars, I think the total OpEx is 106, down from 108 in March, is just the operating lines. But I know you’re doing some investment in building out some sales capacity, but you reduced your run rate of spending in June.

Paul Ricci

I think some of that goes to accruals and – go ahead.

Tom Beaudoin

Some of the benefit, of course, comes from FX. So we did see some pickup in expenses on the FX side. As we talked about, we continued to invest in those critical areas around sales and R&D. But we’re also offsetting that with – we get quarter-over-quarter reductions through acquisitions, as we drive the synergies in those areas. So that’s a benefit to us. And then I think we are continuing to get some synergies on the G&A side. So –

Derek Bingham – Goldman Sachs

Okay. That’s helpful. Thank you.

Operator

And next we turn to the line of Jeff Van Rhee with Craig-Hallum. Please go ahead.

Jeff Van Rhee – Craig-Hallum

Great. Thank you, Paul. Several questions, maybe that would help just clarify on the enterprise side if you’d be willing to help. The subscriptions as a percentage of the enterprise and mobile segment, can you give – at least get us in the ballpark here as to how big that business is right now in terms of recognized subscription revenue?

Paul Ricci

Sorry, we just don’t publicize it.

Jeff Van Rhee – Craig-Hallum

Okay. Then I guess on the enterprise side, if you just speak to the traditional licenses, the traditional license side of business, would you comment on the rate of decline or growth there and sort of acceleration or deceleration, just trends – what you are seeing on the enterprise license side?

Paul Ricci

Licenses have been fairly flat with the last few quarters. There have been some ups and downs, but the overall trend has been flat with direct license sales somewhat replacing sales – license sales from our channels. License sales on our channels this quarter were down somewhat, and there is no one explanation for that. As I’ve said in previous quarters, our traditional telephony equipment channel has gone through and continues to go through a lot of structural changes, and that has clearly adversely affected their selling of our solutions.

Jeff Van Rhee – Craig-Hallum

Does the drag from the channel, has that – the decline there accelerated? Do you feel like that decline is stable? Has it sort of stated to improve? How would you characterize that?

Paul Ricci

I would have described it as stable. This quarter was not a good quarter in that regard, but I don’t think that that’s a strong indication of any particular deceleration.

Jeff Van Rhee – Craig-Hallum

Okay. And then in the prepared remarks, you mentioned the on-demand side enterprise had volume erosion from a meaningful customer. Can you help us on the magnitude, and along those lines, the percent of customers that you’re seeing volume erosion? I mean, have you seen any material changes there?

Paul Ricci

The erosion we saw was in one particular – was in one of the oldest customers in that business. I don’t know the exact amount. I believe it was a few million dollars. What was your other question?

Jeff Van Rhee – Craig-Hallum

Just whether or not you’ve seen a change in the percent of the on-demand customers that are showing similar characteristics or you’re seeing reductions in volumes.

Paul Ricci

Most of our customers are in the growth stage. So we – that's not a widespread trend. But we did have one significant customer with some decline.

Jeff Van Rhee – Craig-Hallum

Okay. One last one, and Paul, from time to time you’ve given just longer term thoughts around the enterprise, mobile and healthcare businesses. I know you’ve combined the enterprise and mobile now. But would you care to offer any thoughts around those segments in growth rates over the next several years?

Paul Ricci

I think the – if you’re asking about growth over the medium term, I think the comments I’ve given previously remain in effect. The mobile business and the healthcare business will be our fastest growing businesses, driven by all the factors that I think you’re aware of from previous discussions. I think the enterprise business will grow more slowly, although with the movement on on-demand, the growth will be I think increasingly predictable and the revenue stream increasingly recurring. And imaging, probably in the same – perhaps slightly slower than the enterprise business.

Jeff Van Rhee – Craig-Hallum

Okay. Thank you.

Operator

The line of John Bright with Avondale Partners, please go ahead.

John Bright – Avondale Partners

Thank you. Good evening. Paul, let me slice the apple a different way on the organic growth question. Are you anticipating a return to double-digit organic growth in FY ’11?

Paul Ricci

I think growth that reaches double-digit in FY ’11 is a reasonable expectation, yes.

John Bright – Avondale Partners

Okay. And on the question, weakness in the enterprise segment, can you characterize the reason behind the ramping delays and the softness in channels? Meaning, is this more customer-specific? Is it economic slowdown related? Is it the business model shift? Or something else?

Paul Ricci

As I’ve commented in recent quarters, there has been a lot of structural change going on in our partners in the enterprise business. And that’s been going on now for a couple of years. It has now worked itself fully through. It’s the – the telephony and communications equipment business has been a very difficult business for several companies for a couple of years now. That may not change soon. I think the general economic environment behind that business is actually improving somewhat although I wouldn’t want to overstate that particularly in Europe, but improving.

And during all of that time, we have, as you’ve pointed out, been going through a business model shift. And that business shift is – two dimensions. The first has been an increased reliance upon our own direct selling to large enterprises that’s been underway for a couple of years now, and it’s been progressing well, particularly as we’ve come out of the macroeconomic malaise. And the second one, perhaps more important, is the migration towards hosted solutions, on-demand solutions among large enterprises, which as I’ve said in recent quarters has been happening to a greater extent than we have anticipated. And so it’s reasonable to expect that that will continue to outperform relative to on-premise sales even among our on-direct selling.

John Bright – Avondale Partners

Okay. I’ve asked a question of you in the past few quarters about what inning are we in, in the shift from on-premise to hosted, particularly in the enterprise. And you’ve said we’re in the early innings. Is that the same answer? Or are we accelerating, slowing down, about the same?

Paul Ricci

Just let me make sure I understood your question. It was relative to enterprise alone?

John Bright – Avondale Partners

Well, if you could talk about relative to enterprise and relative to healthcare?

Paul Ricci

Well, I do think I’ve answered this question before. And I think what I’ve said before is, in some respect, we are in the early innings of what is a fundamental shift in the IT industry, as I think you’re aware. And we’re going to see greater migration towards various forms of cloud-based computing solutions, of which are the ones that we talked about in the context of our own businesses on specific instances. So I think that trend will continue unabated over the next decade. And we’re seeing evidence of that in each one of our businesses. So in that respect, it’s early in all of them.

John Bright – Avondale Partners

But no change in the – no acceleration in the adoption on the hosted; continued the same pace you’ve seen in the last quarter, for instance?

Paul Ricci

Well, the healthcare business has had a pre-rapid acceleration. There has been a pre-rapid adoption for the last couple of years. So I don’t think there has been any – that's gone any further. In the mobile business, as we discussed in previous quarters – in the mobile business, it’s not quite so much a migration as the augmentation of the business with the new set of services, mobile services. And we are seeing an acceleration in the interest in demand for those mobile services. So that is in fact going to accelerate as we go into fiscal ’11. Enterprise, it’s hard to tell. What I’ve said is that the speed at which people have embraced the hosted solutions has been greater than we’ve expected now for some number of quarters, and maybe there is some acceleration there.

John Bright – Avondale Partners

One final question from me. Tom, you’re asked about cash flow, non-GAAP income and cash flow from operations. I think you gave three bullet points associated with the delta. And I just wanted to make sure I think I heard those about right. $11 million from working capital, $11 million from SpinVox, and $6 million in restructuring. Am I missing something in there?

Tom Beaudoin

No, that’s about right.

John Bright – Avondale Partners

Okay. And then the last one, just any initial feedback, Paul, that you might have gotten when your pilot project for enterprise voicemail-to-text services?

Paul Ricci

Please ask the question one more time.

John Bright – Avondale Partners

Any initial feedback that you may have gotten already on your pilot projects for enterprise voicemail-to-text services?

Paul Ricci

I don’t have any news to report there really.

John Bright – Avondale Partners

All right. Thank you.

Operator

And next we turn to the line of Scott Sutherland with Wedbush Securities. Please go ahead.

Scott Sutherland – Wedbush Securities

All right, great. Thank you. Good afternoon. A question on the mobile-enterprise, more on the mobile side, can you talk about some trends that are going on there? With the smartphones growing 50%, but the navigation devices flattening out, is it mostly a shift there? Are you seeing changes in pricing or market share on mobile phones?

Paul Ricci

Well, the mobile industry is an extremely fast-paced industry with an extraordinary set of dynamics going on. As you pointed out, among device classes – if one looks over the course of a few quarters, there are ebbs and flows of various devices that are coming into a bigger presence in our revenue stream and some that are declining. For example, we’ve seen the presence of book reading devices in the last, say, 18 months or two years. And at the same time, as I think you suggest, navigation devices have ebbed. Smartphones are increasing. There is just an extraordinary set of tributaries that are shifting in that mix. I will say I don’t think there has been any – we've often talked about the pricing in mobile industry as being quite intense. So then that remains true. But I don’t think it’s accentuated in any respect.

Scott Sutherland – Wedbush Securities

And any shift on the market share side that you are seeing?

Paul Ricci

You are asking about our market share?

Scott Sutherland – Wedbush Securities

Yes, the smartphone, do you see any changes there or is that fairly stable?

Paul Ricci

I think our overall market share in mobile continues to be quite healthy and probably growing somewhat.

Scott Sutherland – Wedbush Securities

Okay. And quick question, Tom, the interest other income, there is a positive benefit this quarter despite having the higher debt balances. Is there anything that we should think about when we model that forward?

Tom Beaudoin

I think we did pick up a slight benefit this quarter just because of the currency and the translation of some of the balance sheet items. But that’s unpredictable going forward. So I think if you look at the historical models around interest income and interest expense is more how you should do your models.

Scott Sutherland – Wedbush Securities

Okay. Great. Thank you.

Operator

Next we turn to the line of Ilya Grozovsky with Morgan Joseph. Please go ahead.

Ilya Grozovsky – Morgan Joseph

Thanks, guys. Can you talk a little bit about the effort in the cars? I know that obviously you guys have worked with Ford. Are you working with other manufacturers and kind of elaborate on that? Thank you.

Paul Ricci

Nuance has been in the automotive market for many years now, going back to the early part of the last decade. And during that period of time, we’ve built up a presence with most of the major automotive manufacturers, global automotive manufacturers, and many of the Tier 1 suppliers that work with them. We’ve listed a number of those in previous press releases, but we have particular presence with most of the large German automotive manufacturers, Japanese manufacturers and American manufacturers, in particular.

Ilya Grozovsky – Morgan Joseph

Okay. Thanks.

Operator

And we have a question from the line of Brad Whitt with Gleacher & Company. Please go ahead.

Brad Whitt – Gleacher & Company

Hi, guys. Thanks for taking my questions. I’m curious, Paul, whether you saw or can quantify any kind of impact from the two major product releases you had recently, DNS 11 and the PDF, I believe it’s 7.0, whether that had an impact on third quarter revenue?

Paul Ricci

Yes. In both instances, it very likely had a negative impact. And that’s historically the case for us. In the quarters before, we launched a new Windows-based application. We typically see a diminution of revenues, particularly in the channel, but also in our direct revenues from reduced marketing activities and of course the corresponding increase in revenues in the quarter of the launch and the subsequent quarters. And that’s what we are anticipating this quarter.

Brad Whitt – Gleacher & Company

Okay. Any thoughts or plans around adopting ETIF and how that may impact your revenue since you’re having more and more subscription contracts? How should we think about that?

Paul Ricci

Not in the short-term.

Brad Whitt – Gleacher & Company

Okay. Maybe I can maybe grab one more. Paul, I think the stimulus plans looking to pump several billion dollars into pushing physicians towards electronic medical records by 2015, would that revenue starts being dispersed next year. Any thoughts on how we should think about that impacting your business? It seems like it would be a positive.

Paul Ricci

Well, we have discussed that in the past. I think we agree with you that the stimulus for the digitizing of records and the penalties that follow the stimulus, I think, are both incentives in the healthcare provider industry for them to accelerate adoption of electronic records and indeed evidence is that’s happening. We think that’s one of several trends that’s affecting the healthcare industry that is increasing the demand for our solutions. And we think that trend will continue to support us over the next several years.

Brad Whitt – Gleacher & Company

Okay. Thanks for taking my questions.

Operator

And next we turn to the line of Mike Latimore with Northland Capital Markets. Please go ahead.

Mike Latimore – Northland Capital Markets

Yes, good evening. Just a question on SpinVox, where are we in the process of migrating some of those customers to Nuance’s platform?

Paul Ricci

Well, the technical integration between the SpinVox and Nuance engineering efforts is underway. And typically, that kind of integration takes a full year. So that’s a reasonable estimate for you to work off of. I will say just to follow on Tom’s comments earlier that after a reasonably difficult first quarter of that integration, a lot of progress was made this quarter. The losses associated were substantially mitigated. And the business continues to be on target for the revenues we expected in the public comments we provided when we announced the deal. So I think overall the direction of that business is doing well for us.

Mike Latimore – Northland Capital Markets

I think you’ve commented in the past on kind of mobile services, what they could mean in fiscal ’11. I don’t know if you have any additional color on that.

Paul Ricci

So, only to reinforce maybe comments we’ve made in the past, I’ve said in the past that connected services and mobile services will comprise the bulk of our growth in mobility in fiscal ’11. And I think all the trends of the last six months and particularly in reference to the comments I made earlier today about the acceleration of mobile services activities, I think that trend has been reaffirmed for us.

Mike Latimore – Northland Capital Markets

And then in the – just in terms of revenues in the third quarter, were mobile revenues separate from enterprise up sequentially?

Paul Ricci

I don’t have – yes, the answer is yes. I’m looking at someone here. The answer is yes.

Mike Latimore – Northland Capital Markets

Thanks. And then, Tom, on the one customer that’s seen some erosion, was that basically volume or was that pricing or was there a market share shift within (inaudible)?

Tom Beaudoin

The volumes associated with that customer have declined, I think, in part a reflection of that customer’s own market effects.

Mike Latimore – Northland Capital Markets

Okay. Last question, just on healthcare. It sounds like the on-premise healthcare product sales are doing well. What do you largely attribute that to?

Paul Ricci

I think Nuance has created a suite of offerings in its healthcare business that provide an integrated solution of on-premise and hosted technologies that link very well to the trend that was asked by a previous questioner, having to do with the digitization – electronic health records. I think we can offer a complete solution that helps large institutions as they contemplate the migration from their current work flow processes to a highly digital process that incorporates both those hosted and on-premise technologies. And I think that’s been extremely compelling for hospitals. And that is driving our on-premise activity alongside of the first growth that you’ve seen now rather robustly for a couple of years.

Mike Latimore – Northland Capital Markets

Thanks.

Operator

And we have a question from the line of Mark Murphy with Piper Jaffray. Please go ahead.

Mark Murphy – Piper Jaffray

Thank you. You mentioned an OEM contract to shift some technology in netbook computers. And I’m just wondering if you can elaborate on whether that is a major recognizable high volume network or maybe something fringier. And also just how is the technology being utilized on a netbook?

Paul Ricci

I don’t think I can say anything more than that’s a recognizable name. With respect to how it is being used, it’s part of the user interface experience of that device.

Mark Murphy – Piper Jaffray

Okay. And then, Paul, on the myTouch 3G Slide device, I’m wondering if you can comment on what kinds of usage patterns you’ve seen for the traditional usage or I guess what I would think of is voice dialing versus some of the newer and higher value types of usage, like web search and calendar search and SMS dictation and the like?

Paul Ricci

I don’t know how much I can say out of respect for the confidentiality. But perhaps I can offer this comment. We’ve been pleased and to some extent surprised by the robustness of the usage overall. And the extent to which the usage comprises the number of capabilities that are incorporated, speech-enabled capabilities that are incorporated into the phone. You’re probably aware there is quite a great depth of speech functionality on that phone.

Mark Murphy – Piper Jaffray

Okay. And then, Tom, just a question on your organic growth rate here of about 6% in the third quarter, is there any way you could help us just looking at what is embedded into the guidance of Q4? Do you think that that growth rate moves higher or lower in Q4?

Tom Beaudoin

Yes, it’s higher than – that guidance would give us the higher growth rate.

Mark Murphy – Piper Jaffray

If it gets you back in the double digits?

Tom Beaudoin

I don’t know. It depends on which end of the range. I think at both ends, it’s higher than what we were.

Mark Murphy – Piper Jaffray

Okay. And then just final one. It looks like if you calculate your billings off of the balance sheet that the growth there is essentially in line with the revenue growth. I guess I’m wondering – I would have thought the billings growth would be higher, just given that you’ve commented on the shift towards the on-demand subscriptions, which should be producing – or which are producing strong bookings with the deferred revenue component.

Tom Beaudoin

No. I just want to be careful, as we’ve talked about many times. It’s very difficult to look at our balance sheet as a predictor of forward revenues because most of the host of deals that we have are variable in respect to the customer is putting variable volume through. So I’d like a more traditional subscription business. We bill and collect based on that usage every quarter. So that’s not visible on our balance sheet. So all you are saying is deferred revenues associated with more traditional-like contractual pieces of our business.

Mark Murphy – Piper Jaffray

Okay. Thank you.

Operator

And next we turn to the line of Craig Nankervis with First Analysis. Please go ahead.

Craig Nankervis – First Analysis

Thanks very much. And good afternoon. I’m sorry to go back to this, Paul. But just so I feel I understand a little more clearly, we had such a drop sequentially in the organic growth of the mobile enterprise unit yet. The factors on the enterprise side, none of them seemed to be new. So in one sentence if possible, what was dramatic among the sort of factors that have been in existence for a while?

Paul Ricci

Craig, I don’t think there was one dramatic thing. There were several elements in the quarter that are, as you pointed out, continuation of trend that are not new. And I think the combination of those resulted in a weaker than expected quarter in enterprise.

Craig Nankervis – First Analysis

Okay. So it’s sort of a perfect storm, it sounds like. Do you – how quickly does the Viecore business that Nuance services play fill the gap that is being created by sort of ongoing difficulties with channel partners? Does that ultimately get entirely filled or sort of partially in the Nuance view of things if you look out, I don’t know, 12 to 18 months or something like that?

Paul Ricci

Yes, the Viecore business has essentially – has long since become of course the centerpiece of our solutions offering in our enterprise business. And it had been going steadily, and the other number in the prepared remarks that I think we’ve referenced was the backlog of professional – backlog of professional services, which as you can see is up very strongly. And the continued – and that backlog is a reflection of professional services consumed both in on-premise and in our on-demand contracts. And I think it should be an indication to you of what fundamental growth of that is. And yes, as we move into fiscal ’11 and fiscal ’12, those business streams will simply become substantially more important than the historical channels revenues that we’ve enjoyed in past years.

Craig Nankervis – First Analysis

Do you think that – does Q4 guidance contemplate a return to positive growth in the enterprise business on an organic basis? Can anybody say that?

Paul Ricci

I believe it does, yes.

Craig Nankervis – First Analysis

It does?

Paul Ricci

Yes.

Craig Nankervis – First Analysis

I guess that will do it for me, for now. Thank you.

Paul Ricci

Okay.

Operator

And our final question comes from the line of Tom Roderick with Stifel Nicolaus. Please go ahead.

Tom Roderick – Stifel Nicolaus

Hey, guys. Good afternoon. I guess my question – I just want to touch on the margins here a little bit more since you are up almost 100 basis points quarter-on-quarter. Can you help us understand – I know you don’t break out margins by product line, but it seems like you are getting better growth from healthcare and perhaps that’s driving margins. Can you help us understand what the margins might look like across the different product lines or at least directionally which product lines have the best margin profile today?

Tom Beaudoin

Well, we don’t break it out by individual group. As we’ve talked about earlier, on the product side, we’re actually a little bit down year-over-year, but still in that kind of very high 80% and fairly just slightly less than we were last quarter. We have seen, as Paul talked about earlier, and I think somebody else asked the question, we’ve seen a nice uptick in services. And it’s across both professional services and hosting. And I think we’ve talked about the fact that we believe there is continued leverage there and there is continued efficiencies in productivity there.

And then on maintenance and support side, that’s been fairly consistent for a fairly long period. I think within that, healthcare has always been a very, very strong gross margin contributor to us. And mobile, because it’s at this point predominantly a license business, but as some of the services kicks in, we’ll get a lot more gross margin, but the actual percentage might go down slightly on a mix basis just as you get as you have to deliver some of the services. And not a lot of change in imaging. I hope that gives you some indication.

Tom Roderick – Stifel Nicolaus

Yes, that’s helpful. Last question from me, just in thinking about some of the organizational changes you’ve made throughout the quarter and the first half of the year – on the calendar year, can you talk a little bit more about the change of the top of the healthcare division and what’s in that organization as you have the leadership involved? What changes should we anticipate for the coming months?

Paul Ricci

Well, the healthcare business, as you know, has shown strong and improving performance throughout the year, including in the third quarter. We think the fundamental trends in the healthcare business are very good. We brought in Janet to help us capitalize on those trends, and she has been here just a quarter now. So it’s rather early. But I think she is doing that. And I think we should expect to see additional benefits from that, as her tenure progresses.

Tom Roderick – Stifel Nicolaus

Okay. Thank you, Paul. Thank you, Tom.

Operator

And speakers, we will turn it back to you for closing comments.

Paul Ricci

Okay then. We thank you all again for joining us for our third quarter call, and we look forward to speaking to you again next quarter.

Operator

Ladies and gentlemen, it does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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Source: Nuance Communications, Inc. F3Q10 (06/30/10) Earnings Call Transcript
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