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Nuance Communications Inc. (NASDAQ:NUAN)

F3Q07 Earnings Call

August 7, 2007, 8:30 AM ET

Executives

Paul A. Ricci - Chairman and CEO

James R. Arnold - Sr. VP and CFO

Analysts

Jeff Van Rhee - Craig-Hallum Capital

Brent Thill - Citigroup

Tom Roderick - Thomas Weisel Partners

Richard Davis - Needham & Company

Shyam Patil - Raymond James

Scott Sutherland - Wedbush Morgan Securities

Daniel Ives - Friedman, Billings, Ramsey

John Bright - Avondale Partners

Presentation

Operator

Good morning. Welcome to Nuance's Third Quarter 2007 Financial Results Conference Call. Today's call is being recorded.

With us today are the Chairman and Chief Executive Officer of Nuance, Mr. Paul Ricci and the Chief Financial Officer, Mr. Jamie Arnold.

At this time, I would like to turn the call over to Mr. Ricci. Please go ahead, sir.

Paul A. Ricci - Chairman and Chief Executive Officer

Good morning, everyone, and thank you for joining. 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.

Nuance recorded a strong third fiscal quarter with revenues, earnings and cash flows all reflecting a continuation of the favorable trends in recent quarters. We enjoyed solid revenue growth across most of our business lines with especially strong performance in our embedded network and health care market segments.

Sustained budget discipline within our operating units and ongoing synergies from acquisitions translated into enhanced earnings and additional leverage in our operations. And finally, we achieved strong cash flows again this quarter at $30.3 million.

Total non-GAAP revenues in the quarter were approximately $157 million including about $300,000 of acquired revenues otherwise lost to purchase accounting. Total GAAP revenues were approximately $156.6 million. Total non-GAAP revenues were up 30% over the same quarter last year.

Organic revenues in the quarter excluding revenues from BeVocal and Focus were up 18% over the same period last year. Total Speech revenues were $140.3 million. Organic growth in Speech revenues excluding BeVocal and Focus was robust, up 27% over the same period last year.

Revenues for our network and enterprise Speech solutions were $52 million, up 45% from $35.9 million in the same quarter last year. Even excluding contributions from BeVocal, network revenues remain a record for the Company at $43 million, up 20% organically compared with the same period last year.

The team secured important design wins and expanded customer relationships with customers such as ABN Amro, Dell, Hertz Ireland, HSBC, TIAA-CREF and Ticketmaster.

We are especially encouraged at the early results from BeVocal who's on demand solutions help carriers and businesses serving our mobile population manage the customer life cycle from activation and implementation to service and renewal. Revenues for BeVocal in the quarter ran somewhat ahead of our expectations.

Interest in and demand for our Speech based customer care offerings remains strong. Our emphasis on delivering solutions that create meaningful interactions for the customer parallels the heightened expectation of today's consumer.

These consumers have access to more information, are increasingly mobile and likely to share opinions on their experience. This rise in customer expectations necessitates a change in how large enterprises approach their customer service operations.

Nuance's position to help businesses address the shift in expectations with a portfolio of Speech enabled customer interaction and analytical solutions that help companies better support, understand and communicate with their customers.

Also within network Speech our search and communications unit brought new initiatives and offers and expanded relationships with voice search customers and progress in global trials.

We launched Nuance Voice Search, a portfolio solutions for directory assistance and mobile search services providing enhanced capabilities for ad-based services and business listings.

We expanded relationships and initiatives for devices and services for RIM, Palm and Sprint, and we announced new voice search and connective services for Verizon, Rogers Wireless and multilingual access to SwissCom's national directory service.

Turning now to our embedded mobile Speech business, revenues reached a new record for the second consecutive quarter.

Embedded revenues in the third quarter were $14 million, up 46% organically from a year ago as we saw continued strong demand for our solutions and solid performance from automotive, handset and device manufacturers, including DaimlerChrysler, Delphi, Ford, LG, Mitsubishi and Texas Instruments.

We remain quite optimistic about the growth and opportunities in mobile as evidenced by the pace of competitive design wins that we will announce as these products come to market.

Our third quarter for embedded was significant also in terms of expanding the business in our solutions. As you know we've increasingly emphasized our focus on the accelerating market opportunity for mobile device and information services.

To more effectively address the mobile market we announced two important acquisitions in the order, VoiceSignal and Tegic, companies that share our vision for mobile access and the potential to quickly make a growing list of mobile device features, content and services more accessible to consumers.

Combined, Nuance will be better able to develop new and innovative solutions and search capabilities that can more effectively serve the rapidly expanding market for mobile services and applications. We will deliver solutions that allow handset manufacturers and mobile carriers to unlock the potential of the mobile lifestyle with new levels of convenience and productivity.

Moving to Dictaphone, non-GAAP revenues were $56.9 million in the quarter, including the contribution of Focus and up 31% over the same revenue last year. Excluding the benefit of Focus, Dictaphone revenues were $51.4 million, a record level for the Company and up 18% organically from a year ago.

The business continues to perform across both existing and new customer accounts as we secured relationships with several large regional hospitals, including AthletiCo Sports Medicine, Baptist Regional, Colombia Presbyterian and Lifepoint Health.

And within iChart our hosted solution, we continue to see rapid growth and strong bookings as the team signed several multi-million dollar extended term contracts with facilities that include Bon Secours, MeritCare, Sarasota Memorial. Our Dragon product line revenues in the quarter were $17.5 million, up 68% year-over-year.

Please note the year-over-year comparison benefits somewhat favorably because the third quarter in 2006 preceded the launch of Dragon 9, and therefore revenues were soft in that quarter as the channel prepared for the Dragon 9 launch.

Even so, Dragon revenues for the first three quarters year-to-date were $54.1 million, up 45% over the same nine months last year, indicating sustained strength for this product line.

We've seen strong demand that is reinforced by our advertising campaigns and excellent product reviews in mainstream press, including Newsweek and more recently, the Financial Times.

Imaging revenues were $16.6 million, down 23% year-over-year owing to an expected slowdown for OmniPage in our channels prior to the new product launch last week, and to a significant license in the third quarter of 2006 which we did not expect to repeat this year.

Our PDF Solutions, nonetheless, enjoyed another quarter of robust growth with revenues up more than 30% over last year. Among our PDF applications we benefited from increased success among enterprise accounts, including the Department of Justice which we announced last week.

Overall I am quite pleased how Nuance performed in the quarter especially given the significant growth and operational agenda of the Company. Before I discuss the current quarter, I want to turn the call over to Jamie.

James R. Arnold - Senior Vice President and Chief Financial Officer

Thank you, Paul. Good morning, everyone. As you saw in our press release, Nuance GAAP revenues in the quarter were $156.6 million, up 39% over the same period in fiscal 2006. Our GAAP revenues exclude approximately $300,000 of revenues that were lost to purchase accounting in conjunction with Dictaphone and BeVocal acquisitions.

In addition to using GAAP results, we believe it is useful to measure performance using certain non-GAAP measures. Our non-GAAP measure for revenue includes Dictaphone and BeVocal revenues lost to purchase accounting.

Our non-GAAP measure of net income or loss excludes acquisition, transaction and integration costs and as applicable, non-cash taxes, interest in stock-based compensation, amortization and impairment of intangible assets and restructuring and other charges.

With the lost Dictaphone revenues included and the way we review management performance, total Nuance non-GAAP revenues were $157 million for the quarter, up 30% over last year.

To repeat some numbers you heard in Paul's introductory comments, non GAAP Speech revenue was $140.3 million, which included $51.4 million for Dictaphone revenue, $43.2 million in network revenue, $14 million in embedded revenue and $17.5 million in Dragon revenue. Imaging revenue was $16.6 million.

GAAP product revenue was $74.8 million. Non-GAAP product revenue was $75.1 million, up $8.7 million or 13% from $66.4 million a year ago. GAAP professional services revenue, including subscription and hosted applications, was $49.3 million.

Non GAAP professional services revenue was $49.6 million, up $22.8 million or 85% compared to $26.8 million for the same period last year. These figures include approximately $14 million associated with the BeVocal and Focus acquisitions.

GAAP maintenance and support revenue was $32.5 million. Non-GAAP maintenance and support revenue was $32.2 million, up $4 million or 16% compared to $27.8 million a year ago.

North American revenue accounted for approximately 82% of total revenue compared with 80% in the same period a year ago. The increase is largely attributable to BeVocal and Focus, which derive the majority of revenue from North America.

On a GAAP basis Nuance recognized a net loss of $7.6 million or $0.04 per basic share in the quarter compared with net loss of $9.4 million or $0.06 per basic share for the comparable period in fiscal 2006.

Using a non-GAAP measure, net income was $27.8 million or $0.14 per diluted share in the quarter compared with $19.7 million or $0.11 per diluted share a year ago.

Cost of revenue in the quarter was approximately 30% of revenue for a gross margin of 70%, a 1% decrease from one year ago and owing to the increased services within the revenue mix primarily from the inclusion of BeVocal and Focus. Please note that in discussing cost of goods I exclude acquisition related amortization.

Product gross margins were 87% in this quarter as compared to 84% in the comparable quarter of fiscal 2006 owing to a changing mix and product and licensing revenues. Gross margins for professional services were 37% in the quarter as compared to 29% in the same period of last year.

This improvement owes to continued operational progress in our enterprise and network's business services unit, as well as the acquisition of BeVocal and Focus.

Maintenance revenues were 79% in the quarter as compared to 80% in the same period last year. Again, these gross margin numbers exclude acquisition related amortization and stock based compensation expense.

Within operating expenses, I will discuss the cost discussed below excludes certain items including non-cash stock-based compensation, amortization of intangibles and transition and integration costs. Please see the reconciliation on our website.

R&D was approximately $17.7 million or 11% of revenue versus $14.7 million or 12% of revenue a year ago. The increase in absolute dollars is primarily attributable to additional headcount throughout our product lines, including additional Dictaphone and BeVocal teams.

Sales and marketing spending was $40.9 million or 26% of revenue as compared to $33.8 million or 28% of revenue a year ago. This absolute dollar increase for the year-over-year comparison corresponds to an infusion of sales representatives from acquisitions, as well as the expansion of sales personnel and marketing programs associated with our other product lines.

General and administrative expenses were $15.2 million or 10% of revenue as compared to $10.8 million or 9% of revenue in the same quarter last year. The absolute increase comprised additional staffing expense and professional fees.

The relative increase from 9% to 10% of revenues owed to increased litigation expenses, which we expect to mitigate as we move into the first quarter of fiscal, the first quarter of fiscal '08.

Turning to the balance sheet, the Company generated cash from operations this quarter of approximately $30.3 million, driven again by a strong collections effort. DSOs, net of deferred maintenance revenues were 37 days versus 36 days last quarter.

Depreciation was $3.1 million and capital expenditures were approximately $3.9 million. We exited the quarter with unrestricted cash and marketable securities of approximately $176 million.

And now I will turn the call back over to Paul.

Paul A. Ricci - Chairman and Chief Executive Officer

Thanks, Jamie. As reflected in our comments this morning, our results in the third quarter underscore sustained momentum in Nuance's operational performance this year.

With strong demand across our Speech markets, we are confident in the organization's ability to continue this performance in the fourth fiscal quarter even as we continue investments in sales, services and product development in order to prepare for expansion in fiscal year 2008.

Within our network business we expect, as with the third quarter, to see sequential growth as we further leverage our investments in Nuance Recognizer, the BeVocal on demand portfolio, new application, mobility solutions and directory assistance.

Regarding BeVocal our expectations remain consistent with our original guidance in the range for the fiscal second half of 21 to $23 million minus the loss revenues in April of 3 to $4 million owing to the late close of the transaction in that month.

We anticipate sequential growth this quarter in BeVocal revenues. We also anticipate the continuation of strong year-over-year performance in our embedded business, our product line and OEM relationships with major automotive, mobile phone and navigation device manufacturers continued to strengthen.

But we do caution investors against the expectation of sequential growth as we may experience lower OEM royalties in the summer months.

Within healthcare we expect growth from our expanded sales and services teams and continued success in our iChart hosted solution with additional leverage afforded by the Focus acquisition.

We once again anticipate that organic growth in the Dictaphone unit in the fourth quarter excluding the effects of Focus, to be in the range of 18 to 20% when compared to the same quarter last year. We also expect healthcare revenues should be up sequentially in the current quarter.

We anticipate a robust quarter in our imaging business owing to our launch of OmniPage 16 and to the continued performance of our PDF product line. With this new version of OmniPage, the team has delivered another significant step forward in OCR accuracy, formatting and automation and has introduced new innovations, such as digital camera capture and automated highlighting and redaction.

The early days of the launch are promising, and the results more robust than in the same period of the OmniPage 15 launch.

But we remind investors that we will need a sustained performance of that launch through September in order to realize the contribution embedded in our guidance.

With these factors taken in account we expect GAAP revenues in the fourth quarter to be in the range of 171 to $173 million excluding about $200,000 of revenues lost to purchase accounting.

Expenses in the fourth quarter will be influenced by continued hiring in the area of sales, services and R&D. In addition, we advise investors that the OmniPage 16 launch will carry additional marketing and channel expenses.

With this in mind, we expect to realize a GAAP loss between $0.04 and $0.05 and non-GAAP earnings between $0.14 and $0.15 in the fourth quarter.

Finally, we turn to a preliminary discussion of fiscal year 2008. Because the Company has and continues to assimilate several acquisitions during the second half of fiscal year 2007, we thought it appropriate to provide investors an early view of the coming fiscal year.

I hasten to caution investors that these are preliminary estimates that draw upon what is necessarily limited visibility. We offer the information now so that investors can inform their own research analyses and models while cautioning that our view could materially change as we move toward next quarter's earnings call and greater visibility into the coming year.

I will address first our projections for organic growth, excluding the contributions of BeVocal, Focus, Tegic and VoiceSignal. As we look at our market segments, network, embedded, dictation, healthcare and imaging, we largely expect a relative continuation of trends we've seen this year, with moderation in perhaps some of the higher growth rates as we build from a larger absolute revenue base.

We've also included in our guidance a contingency against the possibility that we experience price declines in the business faster than we've experienced or that we anticipate next year and against slippage in an important product release of which there are several in the coming year. With all these considerations in mind, we project organic growth in the range of 17 to 18%.

As you know from earlier conference calls, we provided revenue ranges for the next fiscal year for each of the recent acquisitions. While I'll not reiterate those here for the purposes of this preliminary FY '08 estimate, we've used revenue forecasts for each of the four acquisitions within the previous ranges provided.

As a measure of caution though, we've also allowed a modest contingency against integration risk in those acquisitions. Though we strive toward full achievement in each case we think it prudent to model the more cautious case for now.

Adding those estimates to our forecasted organic range, we arrived at a full-year, non-GAAP revenue range for fiscal year 2008 of $850 to $875 million. GAAP revenues, adjusting for revenues lost to purchase accounting, would be in the range of $830 to $855 million.

Gross margins for the year should improve from fiscal year 2007 by about one point. Actual improvements in each of the component gross margins, product, maintenance and services, will be better than a point but these operating efficiencies are partly offset by a change in the revenue mix toward services.

Our estimates also suggest that operating margins improve by 3 or 4 points in part because of the organic expense levels growing more slowly than organic revenues and in part from the realization of acquisition synergies. Our guidance assumes that interest expenses will be up materially next year to approximately $48 million.

We further estimate cash taxes in the range of 8 to 10%. With these factors in mind, we expect GAAP net income to be between a $0.01 loss and a $0.01 profit in earnings. We expect non-GAAP earnings next year to be in the range of $0.76 to $0.81.

Finally, we also want to provide estimates of adjusted EBITDA for the full fiscal year 2008. We expect adjusted EBITDA to be in the range of 248.5 to 260.5. Please see our website for a GAAP and non GAAP reconciliation.

You should expect us to update all of our FY '08 guidance at the time of our fourth quarter earnings call. This ends our formal remarks, and we'd now be happy to take your questions.

Question and Answer

Operator

[Operator Instructions]

Our first question comes from the line of Jeff Van Rhee from Craig-Hallum. Please go ahead.

Jeff Van Rhee - Craig-Hallum Capital

Good morning, guys. Very nice quarter. Paul, just a couple questions. First, it all went by very, very quickly there but you touched on embedded and pretty significant sequential growth, more so than seen in a long, long time. Can you just give maybe top one or two reasons again why we saw such great sequential growth?

Paul A. Ricci - Chairman and Chief Executive Officer

The quarter was, as was last quarter in embedded, this quarter was above our own internal expectations. And I think it drew not on a single thing, but really on execution across the business. I think it is reasonable to say that the demand for speech within the mobile embedded segment is outpacing our plans.

I think our design wins are beginning to accrue royalties, past design wins are accruing royalties and the performance of those royalty reports suggest that the demand for devices continues to be quite robust. It was very strong quarter in sales activity and also in integration services we delivered. So it really wasn't one thing.

Jeff Van Rhee - Craig-Hallum Capital

Was there anything... I guess what I would call onetime in nature or large prepay or anything else? Or was the bulk of the upside really driven by volume of pre-existing design wins?

Paul A. Ricci - Chairman and Chief Executive Officer

Certainly the majority of the revenues were driven by previous design wins, the large majority of the revenue. There were new deals in the quarter, and some new deals involve... most new deals involve some amount of prepay, and that is true in almost every quarter.

It is difficult to know whether any given quarter what level of those will occur. I was less concerned about that in my advice for the fourth quarter than the fact that simply royalty reports from our OEMs, may be lower in the fourth quarter simply because summer month sales of their devices are lower.

Jeff Van Rhee - Craig-Hallum Capital

Okay, and then on the network side just clarify for me... I know you broke out a lot of the contributions of acquisition and tried to get right down to organic. You had previously looked for 22 to 26% if I remember right, growth out of network for the year.

And that was really from the core business, and now we've got some additions to that. But if you back out the acquisitions are we still comfortable with 22 to 26% core network speech growth?

Paul A. Ricci - Chairman and Chief Executive Officer

I apologize, Jeff, we have not done the calculation to update our full-year growth based on our fourth quarter estimates. What I did say about the third quarter was the growth, organic growth excluding BeVocal is 20%.

I also indicated that we expect sequential growth in the fourth quarter, and I just don't have the calculation to know what that adds up to for the full-year.

Jeff Van Rhee - Craig-Hallum Capital

Okay, that's fine, and I guess just lastly for FY '08, to whatever degree of specifics you can give us at this point, you've clearly added very high-growth, high-margin businesses, but also much of the revenue mix comes from recurring sources.

Can you give us a sense albeit may be crude at this point if you don't have it prepared, how much of the business in '08 is going to be coming on ratable recovery basis and some color on visibility?

It strikes me visibility has changed pretty dramatically in the last two years and this year is really kind of a pivotal year, as well, a big change in what you can see. But talk to us about revenue visibility for the year.

Paul A. Ricci - Chairman and Chief Executive Officer

We've addressed this before, and we have done some recent updates in our calculations. I want to be somewhat careful in noting what we mean by visibility.

We try to divide our revenue streams into those revenues that we consider more visible and those that we consider less visible, more in the traditional enterprise, direct licensing business, for example.

And included in the more visible segment would be such things as professional services that come out of backlog, our healthcare hosted revenues, our other hosted revenues in network, our OEM reports, our OEM royalties from medium and long-term OEM contracts, both in speech and imaging and technical support and maintenance. And I think that that number looking at FY '08 comes to about --.

James R. Arnold - Senior Vice President and Chief Financial Officer

It's about 80%.

Paul A. Ricci - Chairman and Chief Executive Officer

80%, let's maybe being a little cautious, we could suggest you think of a number in the range of 70 to 80%. So I think you're right that our visibility in the business has expanded as a result of that from, certainly from a couple of years ago and even more so as we go into next year.

It is certainly the case that the majority of growth of revenues, the faster growing revenue streams next year are from the relatively more visible businesses, such as speech OEM licensing and our hosted businesses.

Jeff Van Rhee - Craig-Hallum Capital

And I guess just lastly then on the digital imaging side you've got a product launch coming up; we are getting to some very high version numbers here. Do you still expect the kind of sequential boost that we've seen in prior launches?

Paul A. Ricci - Chairman and Chief Executive Officer

Well, the early results from OmniPage, as I mentioned, are terrific. There is... paradoxically there is still a strong demand for a capture product because the movement to the Web and to electronic document management systems has provided an impetus for companies to get that remaining paper documentation they do have.

For example in the case of litigation online and manageable in more efficient ways. So I do think and in addition to that, I think that our imaging business team has done a very good job of expanding functionality of the OmniPage product to incorporate some of the complexities that are arising in a heterogeneous multiformat world, for example.

So I am quite bullish on the OmniPage launch. And of course looking forward into '08 we will have a new version of Dragon, launching in that year. And we saw such robust growth in Dragon 9 over Dragon 8 that I would... I am optimistic that Dragon 10 should perform quite well for us, as well. In part because I think that it is simply making speech at the desktop so much more attractive, easy-to-use.

Jeff Van Rhee - Craig-Hallum Capital

Great. Thanks. Nice quarter.

Paul A. Ricci - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question is from the line of Brent Thill from Citigroup. Please go ahead.

Brent Thill - Citigroup

Thanks. Good morning. Just relative to the '08 guidance, as you look at the operating margin expansion that you've guided for 300, 400 basis points, can you just walk through some of the primary levers of that expansion?

That seems like a fairly nice move relative to what we saw over the last year. So can you speak to where you think the most efficiencies are in the business that you can gain over the next year?

Paul A. Ricci - Chairman and Chief Executive Officer

The two broad sources of efficiency in the business, those that are inherently in the organic, in the existing business and those that come from the acquired synergies. And speaking to the first, as I mentioned we are going to see a point improvement in gross margins.

As I mentioned, the actual underlying efficiencies in the constituent elements of our revenue stream are the gross margins of those constituent elements are improving somewhat more quickly but we are seeing a shift to service based revenues as I alluded to in the earlier question with hosted revenues and so forth.

So there is a margin, a countervailing shift towards lower margin, gross margin revenues. But even so we will see an improvement in gross margins and those improvements are really operating efficiencies, higher utilization rates, lower infrastructure costs, amortized across a broader revenue base in delivery of those services.

Within the operating expense lines we are going to see absolute increases of course in each of our operating expenses. But we will see benefits from the fact, for example in G&A, that we have built out considerable G&A structure over the last couple of years in anticipation of this growth.

And so while we'll have to add additional staff, we are operating on the base of a much stronger infrastructural system with our more robust IT systems, for example, than we've had in the past with a consolidated, unified back office ERP system to give one example.

Sales and marketing expenses are going to grow somewhat more proportionally with revenue because we view the importance of projecting our presence onto the marketplace and supporting our migration to an increased solution strategy as paramount.

But we will still have some relative efficiencies in those areas, and I think R&D you should think of as holding at close to a constant percentage of revenue as we look out into next year.

And then of course there is the acquired synergies and I've spoken to those in previous conference calls but in the case of most acquisitions we eliminate certain amount of G&A expense. We rationalize certain overlapping investments in other parts of the business and I think you're familiar with those.

Brent Thill - Citigroup

Thanks, Paul.

Operator

Thank you. Our next question is from the line of Tom Roderick from Thomas Weisel Partners. Please go ahead.

Tom Roderick - Thomas Weisel Partners

Good morning, guys. Thank you. Paul, I was hoping you could address the recent announcement of the Microsoft and Tellme merger. And could you relay any anecdotal evidence of what you are seeing from a competitive environment?

Have you picked up any competitive displacements from Tellme associated with some of the perhaps confusion or integration risk associated with that merger? And what is happening out there in the marketplace, and are you able to capitalize either on the core network speech business or on the acquired BeVocal business?

Paul A. Ricci - Chairman and Chief Executive Officer

Well, Tellme was not a particularly important competitor in the enterprise network business. They had a relatively small focused customer base, and they had shifted their Focus primarily to directory assistance and their own mobile search offerings.

So I don't think we can say much. Certainly we haven't seen the heightened competitive thrust there, and I don't have much to report about a diminution of their presence there because it was a relatively small factor in any case.

I think it is evident from the announcements that have been made since the acquisition that they do have a focus as part of Microsoft's strategy in mobile search. And it is early on to say much about that.

I think from our perspective the good news about that is that those people who might view that action by Microsoft as competitive to their interest are working more closely with Nuance in a more intense way. But I think we will see benefits from as we look out into FY '08 and in fact some of that is modeled into our expectations of FY '08.

Tom Roderick - Thomas Weisel Partners

With respect to the convertible offering you announced this morning of $150 million, obviously a good chunk of that will go towards paying off some of the acquisitions you've already done. But it certainly does open the potential to do some more acquisitions.

What is your appetite to continue to do acquisitions in the near-term? And can you give us a sense for which areas of your business you would be looking to strengthen in the next 12 months here?

Paul A. Ricci - Chairman and Chief Executive Officer

Well, I am frequently asked about our acquisition approach, and we have inquisitive interest in most... in several areas within our business. And it is probably imprudent for me to try and comment on specific areas. It is not good for increasing speculation on particular targets.

I might say very generally that we see, in addition to the organic investments we are making throughout the business, we continue to see opportunities for acquisitions in each of our major speech segments. And depending on prevailing prices of assets out there, on another circumstances we may pursue them but it is very difficult for me to be more specific than that right now.

Tom Roderick - Thomas Weisel Partners

Okay. Thanks, Paul.

Paul A. Ricci - Chairman and Chief Executive Officer

All right.

Operator

Thank you. Our next question is from the line of Richard Davis from Needham. Please go ahead.

Richard Davis - Needham & Company

Hey, thanks. Paul, just two questions kind of relevant to the margin expansion of the business. When you look at this business are there opportunities? And it seems like you have different verticals but in terms of to cross sell any of these products back and forth between verticals either by your salespeople kind of cross selling and then also almost kind of cross development.

And what I mean by that is have you thought about and what are your generic thoughts about overseas development and things like that because a lot of software companies are doing that these days?

Paul A. Ricci - Chairman and Chief Executive Officer

Let me take them in turn and I want to make sure I understood the second half of your question first, though. I heard the first part about cross sell and then if you could just repeat the --.

Richard Davis - Needham & Company

How much overseas development… like Everence [ph] moving their development to China and India and what have you. How do you just view that because you already have some over there, but on the margin, what do you see on a go forward basis?

Paul A. Ricci - Chairman and Chief Executive Officer

I will speak to both. With respect to the first question the answer is yes, we do see opportunities for leveraging our sales presence in different verticals and different segments for increased placement of our broader product line.

And in fact, the consolidation of our worldwide sales activity under a single worldwide sales structure at the beginning of this last fiscal year with the hiring of Don Hunt, was a predicate to realizing some of those opportunities.

And our sales team has become effective at doing that; in part because we have salespeople who have enterprise reach that can represent a broader part of our portfolio and in part because there is a consultant in the customer's needs between some of our products.

For example the distinction between embedded technologies and our broader mobile search is eroding in some cases as the solutions that are being delivered through carriers comprise elements of both of those. And we think that will be true in enterprises, as well. And so I think your question is correct in its presumption there.

To the second question, Nuance has a relatively internationalized development organization already, and that includes development teams, of course, in several places in North America, including a large development team in Canada, Europe, Eastern Europe, Hungary, Ukraine, as well as in India.

We do expect to see expansion particularly of our engineering efforts in the coming year in India, in China, and to some extent in Eastern Europe. So you're right, we will be internationally even further internationalizing our incremental investments in R&D.

Richard Davis - Needham & Company

That's helpful. Thanks.

Operator

Thank you. Our next question is from the line of Shyam Patil from Raymond James. Please go ahead.

Shyam Patil - Raymond James

Hi. Good morning. Just to understand the organic growth guidance for fiscal year '08, 17%, 18%, I think you mentioned last quarter you expect embedded to grow 30% organically, Dictaphone 18 to 20%. Should we expect network speech to sort of continue to be or maintain as a 20% organic grower?

Paul A. Ricci - Chairman and Chief Executive Officer

In providing fiscal '08 guidance, I... we provided forward-looking guidance in far more detail than we have previously.

I don't want to try and give you growth rates for the individual business element other than what I did say, which is you should expect to see a continuation, a relative continuation of trends you've seen over the last year, with perhaps some moderation of the highest growth elements because we are simply growing from larger and larger bases of revenue.

Beyond that I don't want to be more specific at this point. And maybe I can address that question in our next call.

Shyam Patil - Raymond James

You also mentioned the possibility of pricing declines. Would there be any part of the speech segments where you would expect more pronounced pricing pressure than others?

Paul A. Ricci - Chairman and Chief Executive Officer

Well, I don't expect the pricing declines, but the nature of the business is that particularly over a long period of time, a fiscal year there are going to be occurrences in the market that I haven't anticipated and competitive threats that we haven't fully appreciated.

And therefore, in building our own plans, we concluded that it is prudent to model some level of pricing decline beyond what is in our baseline plan. And that is what I reflected. It is not really a signal to you that there is a heightened pricing threat in one business beyond what we've anticipated, but rather a contingency against the unknown.

Shyam Patil - Raymond James

Okay, and regarding the healthcare dictation segment, can you talk about any changes you've seen in that market given Philips recent announcement to sell a 70% stake in MedQuist, are you seeing your win rate increase? Are you more optimistic about that part of the business that you were previously?

Paul A. Ricci - Chairman and Chief Executive Officer

I have been... my optimism about the healthcare business has grown steadily over the last year, and I think that has been reflected in our conference calls and I would say to you that continues to be the case today. I think you were referring to the MedQuist transaction... that the announcement of the MedQuist divestiture by Philips.

I think what I would say is that Nuance has benefited generally from the fact that hospitals throughout North America have found I think the third party services agencies such as MedQuist, somewhat less attractive in recent years for meeting their needs, both in terms of cost and in terms of their efficiency in deploying new technologies.

And I think we view our solutions as a displacement for those more manual services. And I think that will continue to be true. I don't know whether the divestiture changes what is already a trend that we've been benefiting from in the first case.

Shyam Patil - Raymond James

Okay. And then just my last question, a clarification on Dictaphone guidance. You said you expected to be up sequentially. Was that up sequentially organically?

Paul A. Ricci - Chairman and Chief Executive Officer

Well, yes, it will be up sequentially organically, yes, yes.

Shyam Patil - Raymond James

Thanks.

Operator

Thank you. Our next question is from the line of Scott Sutherland from Wedbush Morgan Securities.

Scott Sutherland - Wedbush Morgan Securities

Hi, great. Thank you. Good morning. A couple of questions that have not been asked already. When you look at your OpEx scale I think traditionally you talked about maybe more 100 basis points a year. Obviously in '08 it is going to be better than that. How do you look at the long-term, is it still going to increase at 100 basis points a year?

Paul A. Ricci - Chairman and Chief Executive Officer

Yes, I think in the past I have said that our objective was to achieve one or two percentage points improvement in operating margins per year. And that is going to be increased this year because of the accumulated acquisition synergies that we will realize over the course of the next year.

But you are right, somewhere between 100 and 200 basis points per year is our objective. And that is, as I've tried to communicate in the past, given the size of the business now that is a goal that takes considerable cost discipline. So it is not necessarily an easy goal.

Scott Sutherland - Wedbush Morgan Securities

As you close acquisition with Tegic and VoiceSignal later this quarter how do you expect that to affect the mix by product, professional services, recurrent services and maintenance?

Paul A. Ricci - Chairman and Chief Executive Officer

It will. Of course, the Tegic and VoiceSignal acquisitions will increase our license revenues and so we will see a relative increase from them in the license mix as we look out over the next year.

Scott Sutherland - Wedbush Morgan Securities

Lastly you kind of gave the implied interest spurt from the debt for 2008. I know you don't have the terms for the convertible debt yet but is there some sort of an implied rate that you are assuming there?

Paul A. Ricci - Chairman and Chief Executive Officer

I can't really speak at all about that beyond what is in today's press release.

Operator

[Operator Instructions]

And we move on to the line of Daniel Ives from Friedman, Billings, Ramsey. Please go ahead.

Daniel Ives - Friedman, Billings, Ramsey

Hey, guys, a question now for the September quarter; is there any affect from Tegic or VoiceSignal in the September guidance?

Paul A. Ricci - Chairman and Chief Executive Officer

We have assumed none in our guidance, so we've included none in our guidance.

Daniel Ives - Friedman, Billings, Ramsey

And VoiceSignal again a second request from the Justice Department, is that kind of expected, would that change the kind of close date?

Paul A. Ricci - Chairman and Chief Executive Officer

I just want to say about VoiceSignal that we are highly confident that VoiceSignal is going to close in this quarter, and we have been working with the regulatory agencies on answering their various questions. But at this point our confidence about a closing is quite high.

Daniel Ives - Friedman, Billings, Ramsey

Okay, and then just lastly, I mean with '08... thanks for giving that guidance... but it is, as you said, maybe a bit conservative. But there is nothing... is there anything you are seeing specifically that is giving you maybe a little cautioning, or is it just more coming out of the box, just being a little more conservative given your guidance?

Paul A. Ricci - Chairman and Chief Executive Officer

Without characterizing whether it is conservative or not I suppose from our perspective what we think is that that kind of margin expansion that sustained organic revenue growth on top of the assimilation of four acquisitions is a robust set of achievements.

And so whether it is conservative or not it certainly feels like a lot of work ahead of us, and I think if we achieve those numbers our shareholders will benefit, and if we find ourselves in a position as time goes on that we are outperforming them, we will certainly speak up about it.

But it feels like a prudent set of estimates given the many operational challenges we have to address in order to achieve them.

Daniel Ives - Friedman, Billings, Ramsey

Good job, and thanks.

Operator

And our last question today comes from the line of John Bright from Avondale Partners. Please go ahead.

John Bright - Avondale Partners

Thank you. Good morning. Paul, you talked about royalty reports from the OEMs and potentially I think you said sequentially down due to seasonality in the quarter. If that is correct is this just seasonality, or is there anything else at play there?

Paul A. Ricci - Chairman and Chief Executive Officer

No, nothing else at play. I am simply trying to give you some caution about the fact that there are royalties stemming from the summer months and there can be a seasonal affect.

John Bright - Avondale Partners

And regarding your '08 fiscal year guidance, if we think about new products, Dragon 10 you mentioned launching; which one of your new products are you most optimistic about? And I think might be the most meaningful to that guidance as we look forward?

Paul A. Ricci - Chairman and Chief Executive Officer

I am hopeful about the new offerings that we have already announced in the enterprise and customer care and network business. Those are, as we said previously, among the largest investments the Company has ever made.

And the nature of those is you don't get a bump in revenues from the immediate launch, but rather you change the demand in the market simply by making deeper functionality that increases levels of automation and so forth.

So it is our hope and expectation that those investments will play out to increase growth rates in that business as we look out over the next year, and certainly we are making concomitant investments in sales and marketing to support that thesis.

We will have additional mobile offerings during the course of FY '08, and that is a market with a lot of momentum as we have described. So if we are successful in achieving the capabilities that we hope to achieve in those launches I think we could benefit tremendously from that in the mobile segment.

Of course, we just launched OmniPage 16 and OmniPage should accrue benefits going into FY '08 based on the new functionality I described earlier. And we will have another important imaging launch in the course of '08. And I think that that should provide some opportunity.

And then finally, as you noted, Dragon has great potential. I'm sorry there is one other area, we will be announcing additional offerings in the healthcare segment in '08. So there can be benefits from that too.

Having said all of that you can tell from what I just... from that list of launches that that is a lot of product activity in the course of the year, and therefore you might understand the point that we noted some contingency in our revenues based on the fact that perhaps we will incur a problem on one product slippage or another.

John Bright - Avondale Partners

Thank you.

Operator

And that was our last question.

Paul A. Ricci - Chairman and Chief Executive Officer

All right. Well, thank you all again for joining us, and we look forward to speaking to you at the end of next quarter. Take care.

Operator

Ladies and gentlemen, this conference will be available for replay after 12 PM Eastern time today through midnight, August 21.

You may access the replay service by dialing 1-800-475-6701 and entering the access code 883018. International participants may dial 320-365-3844 and enter the same access code, 883018.

This does conclude our conference for today. Thank you for using AT&T Executive Teleconference. You may now disconnect.

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Source: Nuance Communications F3Q07 (Qtr End 6/30/07) Earnings Call Transcript
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