Nuance Communications Inc. F2Q08 (Qtr End 03/31/08) Earnings Call Transcript

| About: Nuance Communications, (NUAN)

Nuance Communications Inc. (NASDAQ:NUAN)

F2Q08 (Qtr End 03/31/08) Earnings Call

May 12, 2008 4:30 pm ET

Executives

Paul Ricci - Chairman and CEO

Jamie Arnold - CFO

Analysts

Daniel Ives - Friedman Billings

Jack Van Rhee - Craig-Hallum

Richard Davis - Needham

Shyam Patil - Raymond James

Tom Roderick - Thomas Weisel Partners

Derek Bingham - Goldman Sachs

John Bright - Avondale Partners

Mark Murphy - Piper Jaffray

Scott Sutherland - Wedbush Morgan Securities

Vic Churamani - Lehman Brothers

Yun Kim - Pacific Growth

Craig Nankervis - First Analysis

Operator

Ladies and gentlemen, thank you for standing by and welcome to Nuance's second quarter 2008 conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

As a reminder, today's conference 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 conference over to Mr. Ricci. Please go ahead, sir.

Paul Ricci

Good afternoon, everyone. Thank you for joining us today. Before we begin, I remind everyone that matters we discuss this morning 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 today reported a strong second quarter, continuing many of the trends we've seen in recent periods. Total revenues were a record with solid revenue growth in our mobility, healthcare and imaging markets, and geographically within Europe and Asia. Conversely, we did observe some sluggishness in our enterprise North American market.

In addition, we again experienced strong on-demand and subscription based revenues across our speech market. In total, on-demand and subscription revenues reached $46 million in the quarter, up from about $13 million a year ago owing primarily to higher concentrations of revenue from iChart in healthcare, Nuance's on-demand and enterprise and several voice search services in mobile.

Pro forma, as if we had owned all acquired businesses for the full fiscal quarter, Q2 2007, organic growth of our on-demand revenues was about 67%.

In the press release this afternoon, you will note, second quarter non-GAAP revenues were $219.9 million, including approximately $16.6 million of acquisition related revenues, otherwise lost to purchase accounting. Total GAAP revenues were approximately $203.3 million. Total non-GAAP revenues were up approximately 53% over the same quarter last year. Organic revenue in the quarter was about 14%.

Turning attention to our mobile and embedded solutions, we had another robust quarter as revenues reached $46.7 million, up sharply from the year before. Nuance's mobile and embedded revenue growth benefited from expanded revenues within each of the important market segments, automotive, PND's, wireless phones and carrier based mobile services. Organically, mobile revenues grew about 28% in the quarter.

Turning to our healthcare business, we achieved revenues of $62.2 million in the quarter, up 29% from the same period a year ago. The team signed several multimillion dollar extended term contracts within the quarter contributing to the rapid growth of our iChart hosted services revenue, which was up more than 55% over the last year. In fact, more than 70% of our healthcare revenues are now derived from recurring revenues from our on demand and subscription based offerings or our healthcare, maintenance and support revenues.

Within healthcare, sales of our PowerScribe product line may have been dampened somewhat in the quarter because of a three months delay in final shipment of a new release version. PowerScribe remains the best known and most highly regarded solution for the radiology market and we expect it to perform handsomely following its general release, which is now scheduled for June. Organically, total healthcare sales grew about 15% in the quarter.

In our enterprise network speech business, revenues were $71.2 million, up 79% from that same period last year. Revenue growth in Europe and Asia was quite strong and our enterprise on demand business performed superbly once again with revenues more than doubling over pro-forma second quarter last year in which we did not yet own BeVocal. But enterprise revenues in North America were as I noted earlier sluggish, including royalties from some of our North American IVR partners. Organically, enterprise revenue grew only 7% year-over-year in the quarter.

Although, we do believe, that we will continue to see some softness among the large North American financial services customers. Our aggregate pipeline and forecast for North American enterprise sales in the second half remained strong and I'll discuss that in more detail later in the call.

The Dragon product line generated revenues at $17.4 million in the quarter, about flat from the same quarter last year. Our expectations for Dragon in the quarter were moderate and will remain so in the third quarter as we prepare for the launch of a new version later this year. And finally, total imaging revenue were $22.3 million, up 20% from the same period a year ago, only largely to the success of PDF Converter 5.

During our last earnings call, I discussed several increased investments in our mobile initiatives, as well as enhanced investments in our sales operations internationally. These expenses, did increase within the second quarter, nonetheless operating expense growth, as compared with the first quarter was quite modest even though our annual employee merit increases also went into effect on January 1st.

We took several steps in the second quarter for which the benefits will continue during the balance of the year. These included a reduction in plant hiring and acceleration of consolidations to realize synergies, from recent acquisitions. And finally, as Jamie will discuss in more detail, cash flows from operations were a record in the second quarter.

Now, before I discuss the second half outlook, I want to turn the call over to Jamie.

Jamie Arnold

Thank you, Paul, and good afternoon, everyone. As you saw in the press release, non-GAAP revenues in the quarter were $203.3 million, up 54% over the same period in fiscal 2007. Our GAAP revenues excluded approximately $16.6 million of revenues that were locked to purchase accounting in conjunction with the acquisitions Paul mentioned.

On a GAAP basis, Nuance has recognized that net loss is $26.8 million or $0.13 per basic share in the quarter compared with a net loss of $1.7 million or $0.01 per basic share for the comparable period in fiscal 2007. 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 revenue lost to purchase accounting.

Our non-GAAP measure of net income or loss, excludes acquisition transaction and integration cost and as applicable, non-cash taxes, interest and stock based compensation, amortization and impairment of intangible assets and restructuring and other charges. With these factors in mind, total Nuance non-GAAP revenues were $219.9 million for the quarter, up 63% over last year.

Using a non-GAAP measure, non-GAAP net income was $41.6 million or $0.18 per diluted share in the quarter compared with $23.4 million or $0.12 per diluted share a year ago.

Non-GAAP speech revenue was a $197.5 million, which included $62.2 million for Dictaphone Healthcare revenue, $71.2 million in networker enterprise revenue, $46.7 million in embedded revenue and $17.4 million in Dragon revenue. Imaging was $22.3 million in revenue. GAAP product revenue was $94.3 million. Non-GAAP product revenue was $107.3 million, up $35.6 million or 50% from the $71.7 million a year ago. GAAP professional services revenue, including subscription and hosted application were $72.2 million. Non-GAAP professional services revenue was $74.5 million, up $40.7 million or 120% compared to $33.8 million for the same period last year.

GAAP maintenance and support revenue was $36.8 million. Non-GAAP maintenance support revenue was $38.2 million up 31% compared to $29.1 million a year ago. North American revenue accounted for approximately 76% of the total revenue, compared with 78% from the same period a year ago.

The changes are largely attributable to a strong performance in our European operations, as well as a strong performance in our Asia-Pacific operations, where several of our largest mobile and embedded partners are located, offset by revenues from US centric acquisitions like BeVocal.

Let me turn next to organic growth. As we noted last quarter, we monetize the method by which we calculate organic growth. The new method simply calculates revenue as if it owned all the assets required during the last year in the comparable quarter. Using this method, we achieved organic growth in our nearest markets as follows; embedded or mobile organic growth was 28%, network or enterprise revenues organic growth was 7%. In Dictaphone Healthcare, organic growth was 15%, for Dragon, organic growth was flat, and for imaging growth was 20%.

Turning to cost of revenues. Cost of revenue in the quarter was approximately 33% of revenue for a gross margin of 67%, a three-point decrease from 1 year ago. Our gross margins approved for license; however, as noted above, we had a greater proportion of services revenue, largely because of the inclusion of recent acquisitions in the revenue mix, and because of the increased growth in our on-demand services revenue.

Please note in discussing cost of goods, I exclude certain costs including transition cost, acquisition related amortization and stock-based compensation expenses. Product gross margins were 90% in this quarter as compared to 83% in the comparable quarter of fiscal 2007, owing to a greater proportion of speech licensed revenue particularly embedded speech revenues which have lower cost of goods.

Gross margins for professional services were 28% in the quarter as compared to 36% in the same period of last year. This decline owes to higher levels of on-demand revenues and our healthcare network business units and additional professional services and network. Maintenance margins were 78% in this quarter as compared to 75% in the same period of last year.

Turning to the operating expenses. I'll remind you that the costs exclude certain items including non-cash, stock-based compensation, amortization of intangibles and transition and integration costs. For more information please see the reconciliation on our website.

R&D was approximately $24.5 million or 11% of revenue versus $12.3 million or 17% of revenue a year ago. The increase of absolute dollars is primarily attributed to the additional headcount throughout our speech product line and from recent acquisitions.

Sales and marketing spending was $49.3 million or 22% of revenue, as compared to $36.6 million or 27% of revenue a year ago. This absolute dollar increase for the year-over-year comparison corresponds to increased headcount in our sales organization and additional sales headcounts from our acquisitions.

G&A expenses were $20.6 million or 9% of revenues compared to $12.1 million or 9% of revenue in the same quarter last year. The increase in absolute dollars is due to additional employees supporting the larger business as well as additional professional fees and financing legal. We expect the growth in the third quarter to be quite modest as compared with Q2.

As we've completed the majority of our expansion in sales personnel and our investment in mobile initiatives are all in place and we will realize substantial introduction from our acquisition consolidations.

Net interest expenses were inline with our expectations at $10.6 million, as a rate we earned on our deposit decline inline with the reduction in the Fed funds rates. We anticipate net interest expense for the third quarter to be in the range of $10 million to $10.5 million, as we will benefit from lower interest rates offset by lower cash balance, to invest after we complete the acquisition of these eScription.

Turning to the balance sheet, the Company generated record cash flows from operations this quarter of approximately $41 million as compared to $35 million last year. Please note, that our transition and structuring charges for the balance of the year associated with closing the eScription, will reduce cash flows by between $5 million to $10 million for the balance of the year.

DSO's net of deferred maintenance revenue were 44 days versus 50 days last quarter, owing to strong collections as well as strong sales and maintenance contracts. Depreciation was $4.2 million and capital expenditures were approximately $3.8 million. We existed the quarter with unrestricted cash and marketable securities of approximately $354 million.

And now I'll turn the call back over to Paul.

Paul Ricci

Thanks Jamie. As I noted earlier, our performance in the second quarter underscores a growing momentum in the business and positions us to meet or exceed our financial objectives in fiscal 2008. With strong demand, across our markets and continued discipline in our operations, we have confidence in Nuance's ability to sustain and in some cases accelerate our performance for the balance of the year.

The following five factors should influence Nuance's performance for the second half for the fiscal year. First, our mobile business should continue to provide solid year-over-year revenue growth reflecting the extension of trends previously discussed and aided by intensified interested for speech on Smartphones and for voice enabled services by carriers and internet services firms.

Second, our enterprise business in North America will, we believe, show improved growth based upon the strength of our current pipeline and services backlog. We see increasing backlog in enterprise services owing to the early success of our Viecore unit. We also note that our licensing pipeline remains solid and not dependent upon a small number of large deals. We expect organic growth for this business to achieve 15% in the second half.

Third, we will benefit from the launch of several dictation-based solutions including the previous referenced release of PowerScribe for radiology and the worldwide launch of Dragon Naturally Speaking for professional and consumer markets.

Fourth, we will continue to benefit from budgetary discipline and expenses should rise only modestly in the third or fourth quarter owing to significant expense consolidation related to acquisition as Jamie mentioned.

And finally, we will realize revenue and margin benefits from the eScription acquisition, which we expect to close later in the quarter.

With these factors in mind, we expect non-GAAP revenues in the third quarter to be in the range of $229 million to $234 million, including approximately $13 million of acquisition related revenues that will be lost to purchase accounting. We expect GAAP revenues to be in the range of $217million to $221 million. We expect non-GAAP EPS to be between $0.20 and $0.22, and GAAP EPS should be a loss between $0.07 and $0.09.

Turning to the full year, we're increasing our non-GAAP revenue guidance for the full year to now be in the range of $913 million to $920 million, including approximately $52 million of acquisition related revenues that would be lost to purchase accounting. We expect the GAAP revenues to be in the range of $861 million to $868 million. We are also revising our full year non-GAAP EPS guidance, which we now anticipate being between $0.80 and $0.82. The GAAP EPS loss should be between $0.25 and $0.27.

That concludes our formal comments, and Jamie and I would now be happy to take your questions.

Questions-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question from the line of Mr. Brent Thill from Citi. Please go ahead.

Unidentified Analyst

Hi. This is (inaudible) for Brent Thill. You talked about the North American enterprise business, I mean how do you see that trending other than for the large deals? Do you see any difference in trends so far?

Paul Ricci

I am sorry. How do we see it trending other than what?

Unidentified Analyst

Other than for the large deal that you had mentioned, I’m referring to the dependence on the large deals that you are not seeing?

Paul Ricci

Well, I do not think there was a noticeable trend. We have seen among financial services customers, some slowing down in their purchasing. We expect among financial services and that is our second or third largest vertical market in the enterprise. We expect to see that sector to continue to be sluggish. However, the pipeline remains strong. The point I made was that we have a robust pipeline and we are not in a situation where we are dependent on our closing a small number of large deals over the reminder of the year. So my view is the backlog in our services business which is robust, the strength of the pipeline and the growth of our on-demand revenues in that segment, will allow us to have a very reasonable second half.

Unidentified Analyst

Okay. On the organic growth rates that you had mentioned, if you had used a previous methodology, would they have been materially different? Do you have a sense in that? Thank you.

Paul Ricci

Well, with a lot of urging from analysts and investors at the beginning of this year, we switched to this methodology. Simply because, it was more consistent with how we found investors calculating organic growth. So I do not want to start going back and forth between the two methodologies.

Unidentified Analyst

Okay. Thank you.

Operator

Thank you and our next question is from the line of Daniel Ives from Friedman Billings. Please go ahead.

Daniel Ives - Friedman Billings

Yes thanks, on the healthcare side, what trends have you seen to accelerate that business specifically within the US?

Paul Ricci

Well I think the most important trend of all is the accelerated migration towards a hosted and an on-demand solution. That is the single trend that probably dominates all of them. However, as I have said in previous calls, the overall interest in demand we are seeing in the business is quite good, and I expect that to continue throughout the balance of the year. We continue to be quite optimistic about that business.

Daniel Ives - Friedman Billings

Okay. On the mobile side, I mean you have already announced a bunch of next generation wins. Can you talk about that market? Is it trending in line ahead of expectations and the traction you are getting or within the next generation of handsets?

Paul Ricci

The mobile business has outperformed our own internal expectations for most quarters, for the last while now. May be the last year or more, and that was true again this quarter. We have of course increased our expectations and so that is not quite as dramatically true, as it used to be. However, I see, as I said in my comments, demand for speech in essentially every mobile form factor and increased interest among carriers and other services firms for network based voice enabled services to terrific market right now.

Daniel Ives - Friedman Billings

Can you talk about the enterprise, over 15% growth on the enterprise segment second half? Is there any chance of a 15% bigger second half growth?

Paul Ricci

Some of it is just timing of our pipeline. However, it does assume, we will see mitigated performance in the financial services market in particular.

Daniel Ives - Friedman Billings

Okay. Thank you.

Operator

Thank you. Our next question from the line of Mr. Jack Van Rhee from Craig-Hallum. Please go ahead

Jack Van Rhee - Craig-Hallum

Great thanks. Paul may be to start on the enterprise side again. The differences you have seen in terms of the traditional enterprise versus the on-demand businesses? It sounds like it is a very notable difference. Can you just talk to that and how each of those businesses trended through the quarter.

On the enterprise side, you commented the affect of the more bullish outlook as it relates to second half. You mentioned Viecore coming in with the solution sale being a big driver there. What other than Viecore is driving that? Or is Viecore that much beginning to change you in terms of being able to bring the whole solution?

Paul Ricci

Well, I think Viecore has certainly been an important element of our positioning the business as a solutions sale surrounding the core technology with applications and providing customers a high degree of service support and ensuring that they have successful applications. I talked about that a lot in, over the last year on our conference call. So, I will not belabor that again. However, that has been an important part of the business and it, I think, it has resulted in a business that is much less dependent upon quarter-to-quarter license revenues.

We tend to have longer service oriented engagements that involve licenses but not exclusively licenses. That is a trend I expect to continue. It is complemented by the on-demand business which is a terrific business with, of course, very long sales cycles because you are doing substantial reengineering of some customer processes in that.

However, I do not have anything in particular that is driving the second half performance other than the specifics of our pipeline as we see it today. We have a lot of experience in this. So, I think it is a reasonable estimate and, it is consistent with the long-term trends of the business.

Jack Van Rhee - Craig-Hallum

Would you talk to whatever degree and give us some color on how to think about gross margin. Do you have a lot of moving parts here, some fundamental improvements within each of the lines but, also makeshifts going on? Help us how to think about gross margin progression for the next handful of quarter?

Paul Ricci

You should see an improvement in gross margins for a couple of reasons. First, the eScription acquisition will improve gross margins. Second, the mobility business tends towards higher gross margins because of the high royalty margins. Third, there are a lot of class initiatives underway in the company and we tend to chip away at our margins in any case.

As we have discussed previously, we have deployed within healthcare the same management team that was able to improve our gross margins in our enterprise services over the last few years. I think our on premise services for gross margin for healthcare will improve as we go through the next year as well.

Jack Van Rhee - Craig-Hallum

Has the on-demand side of the business changed in terms of competitive landscape win rate, markets where you are seeing strength or weakness, just a little more color on that, if you would? I am talking specifically on the on-demand enterprise.

Paul Ricci

Well, I think the only thing I would say is, there does appear to be a growing interest in on-demand and that maybe for a number of factors, that maybe competitive. However, I think it is just a general interest in the on-demand solutions that we have in our particular focus verticals.

Jack Van Rhee - Craig-Hallum

Okay. Great. Thank you.

Operator

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

Richard Davis - Needham

Hi. Thanks. On the healthcare dictation side, it is a fragmented market, as you know. Could you talk about how you think of blending your software technology with services and directionally what are your thoughts on that in that manner?

Paul Ricci

I think I understand you question, but if I get it wrong, feel free to ask it again. I think you are asking to what extent will we be providing the software solution, to what extent will we provide labor services (inaudible) with that?

Richard Davis - Needham

Correct, correct.

Paul Ricci

We are predominantly the former and not the latter and that, we expect that to continue. We do have a relatively small amount of our own labor services that we provide, primarily because some customers very much want a complete solution and do not want to have to manage multiple vendors. We want to be able to satisfy those customers. It is also been an important, an abler for us to accelerate the development of our technology in some ways. However, the amount of services that will be done by our partners will greatly exceed that which we do, vastly exceed.

Richard Davis - Needham

Got it. Okay. That was my main question. 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 afternoon. Back to the enterprise segment, the 15% growth you expect in the back half of the year, can you talk about where your pipeline might be concentrated in terms of maybe the top two or three verticals? What is your expectation for licensed growth? Is that something that should grow in the single digits or do you expect it to grow in the double digits in the back half of the year?

Paul Ricci

Well, first I should say, geographically, you should look for our enterprise business to do quite well outside of North America. We have made a lot of investments over the last year in Europe and those have been paying off quite handsomely for us in the last couple of quarters and that is also true in the Asia-Pacific market. So we are going to see faster growth rates for the balance of this year outside of North America and we are in North America and it is just important to underscore that.

Within North America, the important verticals continue to be telecommunications, travel and hospitality, financial services, some retail and utilities. I do not think that is going to change dramatically. As I said previously, financial services is certainly going to have a weaker year than it did last year. However, it is a relatively contained part of our overall business. What is your other question on the pipeline?

Shyam Patil - Raymond James

Just what your expectations are for license growth in the back half of the year?

Jamie Arnold

License growth and services growth in this business are going to continue in tandem, I would expect them both to be in double digits.

Shyam Patil - Raymond James

Okay. When you look at the competitive landscape on the mobile side, there is a well known competitor that had a launch recently. Have you seen any material change there, is it getting a little bit more competitive to handsets, any change in pricing?

Jamie Arnold

There has always been competition in mobile and there will continue to be competition from various directions. I do not think I would tell you there has been any significant change in the competitive structure in the last six months.

Shyam Patil - Raymond James

All right. Then, when you look at the mobile business and the portfolio of applications there, where do you see the most opportunity? Not necessarily this year, but '09 and beyond?

Jamie Arnold

I apologize, but I am not sure exactly what question you are asking?

Shyam Patil - Raymond James

When you look at your specific mobile applications that you have in your portfolio, specifically for handsets, where do you see the most opportunity in terms of revenue, not necessarily this year, but next year and beyond?

Jamie Arnold

Well, I think as we look at over the next 24 months, we expect to see increased penetration of speech-enabled solutions on the handset, and we have talked about what some of those are. However, they will certainly include the ability to, for command and control the device itself as well as creating short messages and perhaps voice enabled content receivable on the device.

The single most important factor in the mobile business for us will be increased penetration from what is in round numbers, a couple of 100 million devices or so, shipping per year right now to a much larger fraction of that market. We expect that to continue. We are quite excited by the interest, particularly in higher-end phones right now. We think that those provide leadership that trickles down to other phones over time.

Then secondarily would be voice-enabled services as deployed for the most part by the carriers, but not exclusively by the carriers, by any means. Again, those services we have talked about in the past, but there are services for some form of information retrieval, message dictation, perhaps voice message transcription and I think, you are probably generally familiar with those. I think those are going to be the two most important factors for growth over the next couple of years.

Shyam Patil - Raymond James

Okay. Then just my last question, we are just about four and a half months less than the fiscal year. As we look out to '09, is there anything that would make you cautious on what you have commented as your long term growth rate of 20% and one to two points of margin expansion?

Paul Ricci

I remain actually quite optimistic about the company's growth potential. Of course like everyone, I have some concerns about what the economic or the macro-economic climate in North America would be like, as we look out over 2009, but I am not an economist and I do not presume to predict that. With that caveat, I think that the underlying demand for our functionality and the capabilities and our solutions is growing.

I have talked repeatedly about healthcare. I do not think there is going to be a diminution in the focus on reducing cost for medical documentation, healthcare documentation in healthcare. So I think we are really well poised to take advantage of that demand. Mobility, I think again, is a market where the fundamental demand for speech enabled capabilities is quite strong, and I actually think that the enterprise business could prove somewhat countercyclical, because the technology is cost displacing and with some time, a number of our customers will focus on that aspect of the speech solution in the enterprise and I think that will be to our benefit and in any case, there is a significant transition going on, architecturally, in call centers and the enterprise and I think that too continues to motivate the migration towards speech.

Shyam Patil - Raymond James

Great. Thank you.

Operator

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

Tom Roderick - Thomas Weisel Partners

Hi. Good afternoon. Thank you. Paul, you indicated that you have seen some nice early success from the Viecore unit. Can you quantify what that meant on the quarter and also with respect to any impact of that that the services work there would have had on the operating margins, is this 24% level the right level to think about as we model for the back half of the year or is that more of a reflection of the comps -- better than expected strength coming Viecore there?

Paul Ricci

I can not give you specific numbers for Viecore. We do not break those out. I can not talk qualitatively about the various influences. Certainly, the Viecore margins pulled down our overall margins, but those margins will go up with time. There certainly was some disruption as we integrated our enterprise services with the Viecore units but I view that as the transitory thing and I am not concerned about it. What else did you ask?

Tom Roderick - Thomas Weisel Partners

Just in terms of whether this margin level was at the right level to model going forward throughout the year or as you mentioned you might see a little bit of the bounce back as you become more efficient within Viecore.

Paul Ricci

No. I think you should expect to see services margins improve and I think you have seen in the past what our enterprise services margins have achieved. We may not be back at that place in short order, but I do think we will see margins improve.

Tom Roderick - Thomas Weisel Partners

Okay. Great. Then just one last quick question, in terms of your guidance for the year, can you remind us what impact you are assuming from eScription on the topline for the remainder of the year within the context of the full year guidance and Q3?

Paul Ricci

I think I said that eScription, at the time of the announcement was $0.16 to $0.18 and $0 to $0.01.

Tom Roderick - Thomas Weisel Partners

Okay. So that is still hold I presume?

Paul Ricci

Yes. I have not changed that

Tom Roderick - Thomas Weisel Partners

Okay. Thank you.

Operator

Thank you. Our next question from the line Derek Bingham from Goldman Sachs. Please go ahead.

Derek Bingham - Goldman Sachs

Hi. Thanks. I was wondering, if amongst the major segments and embedded if any particular one of those really stood out?

Paul Ricci

I am sorry. I have to ask you to ask your question again. There was a brief interruption.

Derek Bingham - Goldman Sachs

Sure. In the embedded market, I was wondering amongst the auto handsets, PND's and connection services, any one of those or a couple of them that were really the stand out in the quarter for you?

Paul Ricci

I am happy to say that, the services all of the segments of mobility showed very good performance. We are doing quite well in each of our target segments there.

Derek Bingham - Goldman Sachs

Okay. Have you had to adjust any of your assumptions for that segment this year, just given that maybe some of the industry data on handset or auto shipments to slowdown maybe from where we thought that might be it exiting '07?

Paul Ricci

That is not the primary variable that influences our revenues. We are much more dependent upon the rate of adoption then we are at the growth. If you think about the handsets or maybe a $1.1 billion and whether their growth rate is up or down a couple of percentage points, we can make a significance difference obviously to the suppliers in that industry?

However, what is far more important to us is the rate of penetration going from 10% penetration to 20% penetration this year or I do not quite the right number. I think you understand my point.

Derek Bingham - Goldman Sachs

Now that makes sense. On that point, your adoption assumptions have not changed at all from--?

Paul Ricci

No. the adoption assumptions have not yet changed.

Derek Bingham - Goldman Sachs

Okay. Perfect. Then--?

Paul Ricci

Actually, I think that there is some evidence that that the adoption rate is increasing, but I can not really quantify that. So I can not say much more about it.

Derek Bingham - Goldman Sachs

Okay. On the Dragon, you mentioned it is just coming out at the end of your fiscal year, so is it right to see some of that boost in the September quarter?

Paul Ricci

In the fourth quarter, yes.

Derek Bingham - Goldman Sachs

Is there, should that be comparable in terms of what that release is bringing to the market, comparable in terms of how we have seen the up tick on from prior cycles?

Paul Ricci

Yes. I think that is the best information we have. So we have a launch plan to be comparable with previous launches. Hopefully, we have learned from those launches and we will have to see.

Derek Bingham - Goldman Sachs

Okay. Thank you very much.

Operator

Thank you. Our next question is from the line of Mr. John Bright from Avondale Partners. Please go ahead.

John Bright - Avondale Partners

Just a couple of question is here. First, specifically, in enterprise business you were talking about the strength internationally relative to domestically. I am wondering if you could maybe talk about the size of the international component in enterprise relative to domestic, and maybe if you could talk about that in mobile and embedded as well.

Paul Ricci

No, I do not have international broken down here by the various markets that we are in, but I think it is reasonable for you to use a relatively proportional number to the aggregate number.

John Bright - Avondale Partners

Okay. If you could talk about how the structure of that segment looks now between, say, automotive handsets, PNDs and other. Maybe if you could rank those in terms of size and how you see that going forward.

Paul Ricci

In relative, in ranking, the size would be the wireless, automotive, P&Ds and carrier-based services.

John Bright - Avondale Partners

Do you expect that to remain intact, going forward, you think?

Paul Ricci

Well, the services are certainly going to grow more quickly than the other segments. Other than that, it is probably a reasonable relative ranking for the next year or so.

John Bright - Avondale Partners

Okay. If we could shift and talk about taxes; We noticed a pretty lox tax expense this quarter seemed, and maybe before, previously you have talked about 15% cash tax rate and is that really a fair assumption still going forward?

Paul Ricci

I will let Jamie handle that.

Jamie Arnold

I think the current tax rate for this year is going to be lower than 15%. Give me one second. I think you could use about 7%.

John Bright - Avondale Partners

Okay. Lastly, looking at operating expenses, maybe you could talk a little about where specifically you think you can get operating leverage and synergies and where you think you are going to have to make more investments?

Paul Ricci

Our primary areas of hiring will continue to be R&D and sales. We will have some services personnel hiring for the balance of the year, but not too much; primarily, R&D and to some extent sales. I do think we will see significant leverage over the third and fourth quarter because of the consolidations related to the past acquisitions as well, that related to eScription. So as both Jamie and I mentioned in our comments, you should look for modest operating expense growth, quite modest operating expense growth this quarter and relatively limited next quarter.

John Bright - Avondale Partners

All right. Thank you.

Operator

Thank you and our next question from the line of Mr. Mark Murphy from Piper Jaffray. Please go ahead.

Mark Murphy - Piper Jaffray

Thank you. What affect has the Ford and Microsoft Sync project had on the industry just in terms of awareness of speech solutions out there and do you have an estimate of how long you think it would be until other automakers start to follow suit there?

Paul Ricci

Well prior to the Ford announcement, most automakers, in fact I would guardedly suggest, say to you, essentially all automakers of any consequence had speech deployments underdevelopment or in place. So I think that the Ford Sync announcement has been quite a visible confirmation of a trend that was well underway and that trend seems to be continuing. I do not it is marked a significant change in that trend.

So just to be clear about that, we have announced a number of engagements with other automotive manufactures and their tier one suppliers over the last several years and we have numerous other engagements we are working on now that go out through 2010 and 2011 and I think that that is a trend that is only going to continue particularly, as we see more and more legislation of the kind that we have seen in some states in the US that are restricting the ability to use cell phones in the car.

Mark Murphy - Piper Jaffray

How about Paul, any thoughts in the Apple iPhone? I know, we have seen some demos out there on YouTube, of some technology that you have acquired running pretty nicely in the iPhone. It looks like that you are probably launching some new version something or so. From your prospective, is it ultimately in Apple's best interest, you expand the command of control for that device?

Paul Ricci

It would be beyond presumptuous of me to offer advice to Apple on user interface technology. They seem to be doing smartly well without my advise. So I am going avoid it, offering an advice.

Mark Murphy - Piper Jaffray

Okay and then just the final one. What was the overall organic revenue growth across the entire company using the new definition?

Paul Ricci

14%.

Mark Murphy - Piper Jaffray

Okay. So, based upon your commentary about expecting some of your segments to potentially accelerate in the back half of the year, is it still reasonable for us to be thinking about high teens to may be 20% organic growth as a good assumption going forward?

Paul Ricci

When I gave the guidance at the beginning of the year of 857 to 900, I believe that that embedded organic growth in the middle of that range of 17% or 18%, I have forgotten precisely. Today we are suggesting 913 to 920. So I think short answer to your question is yes. It essentially embodies the same growth in the range you just mentioned.

Mark Murphy - Piper Jaffray

Thank you.

Operator

Thank you. Our next question from the line of Mr. Scott Sutherland, Wedbush Morgan Securities. Please go ahead sir.

Scott Sutherland - Wedbush Morgan Securities

Hi. Great. Thank you. Good afternoon. A couple of questions on your mobile embedded space. On the mobile phones, obviously, you are extremely doing fine, but it is more than lower insight. So can you talk a little bit about your exposure and where you would like to see the growth in mobile phones, you have more leverage on the smartphones, is that where you like to see grow, or is it just overall phones? I know you mentioned earlier you want to see penetration increase and that is the main driver.

Paul Ricci

Well, volume wise, the mid-range of the phones market is the most important one for us. I think in the industry those are known as feature phones. So, that remains our single most important segment. However,, of course, we are quite excited by this smartphone implementations because they can, in some instances have a more robust implementation that I think can help trickle down overtime.

Scott Sutherland - Wedbush Morgan Securities

On you PND and auto space, how material is the ASP price increases of speech-to-text? Are you seeing the impact now. I know you saw launches of the PND space in the last quarter, is that more to come?

Jamie Arnold

There has been a lot of activity in the PND space and that is been true from the first time we saw sales in PND. It has been an explosive segment for the manufacturers and as they have embraced various forms of speech solution first, text-to-speech and then speech entry, it just continued to be a terrific segment for us and I think we are still in the relatively early stages of the ladder technology of speech entry in these devices. So I think it is going to continue to be an important sector for us.

Scott Sutherland - Wedbush Morgan Securities

Okay. Thank you.

Operator

Thank you. Our next question is from the line of Vic Churamani from Lehman Brothers. Go ahead. Please go ahead, sir.

Vic Churamani - Lehman Brothers

Yes, Hi. Just, Paul, just to clarify to make sure your guidance does not include eScription. Is that correct?

Paul Ricci

No, it does include eScription.

Vic Churamani - Lehman Brothers

It does?

Paul Ricci

Yes.

Vic Churamani - Lehman Brothers

The 16 to 18 is embedded in 930 and 920.

Paul Ricci

Yes.

Vic Churamani - Lehman Brothers

Okay. Then on the tax rate, Jamie, is it fair to say, the tax rate assumption is a little bit lower for the second half?

Jamie Arnold

Yes.

Vic Churamani - Lehman Brothers

Would you give us, maybe perhaps, a longer term, maybe even if you would want to comment on '09, what we should expect for tax rate?

Jamie Arnold

We will talk about '09 when we get a little closer to '09.

Vic Churamani - Lehman Brothers

Okay. Fair enough. Lastly, Paul, on the call center side, I know you mentioned that North America business did feel a bit of a softness. Is your expectation, going forward, that it remains steady? What would be your expectations for the call center side?

Paul Ricci

I think the second half is going to be more robust than the second quarter, as I mentioned in comments earlier. I think that will be driven just by the pipeline we have in place and the backlog we have in place.

Vic Churamani - Lehman Brothers

All right. In terms of the second half, is it more international? Because you mentioned international will accelerate.

Paul Ricci

International will certainly grow more rapidly than North America. That is been true for a while. However, we have seen quite a good performance internationally in the enterprise that is, in part, because we made significant new investments in Europe, in Japan, in particular in this space over the last year. They have simply been paying off.

Vic Churamani - Lehman Brothers

Okay. Then just on the hospital, on the healthcare side of the business, you have seen some articles in the press and it seems like on the hospital side of the business, there seems to be more CapEx spending pressure facing hospitals, specially as some of the electric procedures have reduced at hospital the revenues going to pressure. Do you expect any impact on your business going forward more in tune to the on-premise side versus the on-demand side?

Paul Ricci

It could be. I can not say we have seen it today and I am not anticipating it. Maybe that that is a partial explanation for the migration towards the on-demand solution though it is not usually the reason given, but it could nonetheless be, it is a partial explanation.

Vic Churamani - Lehman Brothers

One last question on pricing on the mobile side of the equation; do you expect pricing to be steady or if you can just give us your high level thoughts on pricing on the mobile piece?

Paul Ricci

Here at Nuance, we always expect prices to go down and we model our businesses if prices are going down. Certainly, there has been pricing pressure since the first day we were in the mobile business in 2002 and I think that will continue to be true. However, I do not expect to see anything that is discontinuous with recent trends.

Vic Churamani - Lehman Brothers

Great. Thanks, Paul

Operator

Thank you and our next question is from the line of Yun Kim from Pacific Growth. Please go ahead.

Yun Kim - Pacific Growth

Thank you. Can you just clarify how much of your enterprise business is driven by on-demand solutions versus on-premise or cost inter sale? Then also I just want to make sure on the accounting of the on-demand sales, is it everything is recognized, are they are all services revenue or are there some breakout between maintenance and services for on-demand sales.

Paul Ricci

For the latter question it is in services and to the former question I am afraid, I can not break it out. We do not publish product line revenues. I did give you some information today about the aggregate on-demand revenues across the company and I think I told you that those revenues were about $46 million in the quarter across all the speech markets.

Yun Kim - Pacific Growth

Great. Would you speak about any progress you have made in the Voice Search market? As you know a company called vlingo has a working product with Yahoo. Anything you can tell us regarding the voice search market, and where do you think it is today? When do you think you will ramp up to a pretty significant size? Thanks.

Paul Ricci

As I have said in past calls, there is great deal of interest among carriers and Internet services firms in various voice enabled services of which voice search is one. We are going to see a lot of trials and we are going to see early prototypes. What is more interesting is what are going to be the sustained revenues. We have activities underway with a number of carriers in particular and some other partners. That I think have shown, steady growth from small bases and revenues and we are going to see rapid growth.

As I reminded investors in the past, it is an early business. It involves lot of expense. I think its medium-term potential is terrific. Its growth rates will be very impressive because it comes from a small base. However, they are going to continue to be relatively small businesses for the next 12 or 18 months.

Yun Kim - Pacific Growth

Okay. Great. Thank you very much.

Operator

Thank you. Our final question from the line Craig Nankervis from First Analysis. Please go ahead.

Craig Nankervis - First Analysis

Thanks very much. Just a couple of questions. First of all on the enterprise side, you talked about lower royalties from your IVR partners. Was that across the board from your major partners or was it just may be one or two partners that you saw weaknesses from?

Paul Ricci

We have seen share shift among our partners and I am not going to comment on that at all in particular. However, a couple of our partners did have noticeably worse quarters than they have had in the past in their selling of our solutions

Craig Nankervis - First Analysis

So it was not per se across the board. It does not sound like.

Paul Ricci

No. That is right. Well, total revenues, total royalties from partners were lower. There has been within that some shared shift, but a couple of them were meaningfully lower than the others.

Craig Nankervis - First Analysis

Thanks for that Paul. You are confidence in your enterprise pipeline in the second half comes from -- you are just factoring weakness in financial services in a way that you did not factor it in Q2. What is different about your pipeline in your backlog versus going into Q2 now that you are now going into Q3?

Paul Ricci

I think you have answered the question partly yourself. That is, that we have factored out a fair amount of financial services out of the pipeline. We also have completed the integration of the Viecore selling and services activities with Nuance's enterprise selling and services. So, I think the integrated pipeline is clear to us, and the periods in which we will have recognizable revenue from that is clear to us than it was in the last several months.

Craig Nankervis - First Analysis

Okay. That is helpful. Lastly, we refer to ongoing cost reduction initiatives. I was wondering if there has been any new unplanned cost reduction initiatives you have undertaken, say, in the last three months?

Paul Ricci

Well, Nuance has always been a company to look at new cost efficiencies in the business and we have continued that over the last six months of this year. It typically involves expenses that can be reduced as we move through a milestone of some acquisition integration, but not always that, but primarily that. So I do not think there is anything noteworthy to tell you or extraordinary to tell you. However, we continue to make cost adjustments in the company throughout each quarter. I expect that to continue for the remainder of the year.

Craig Nankervis - First Analysis

Okay. That does it for me. Thanks very much.

Operator

Thank you. That does end our question-and-answer session at this time. I will now turn it back to our host for any closing remarks.

Paul Ricci

All right. Well, Jamie and I thank you all for joining us and we look forward to speaking with you again next quarter. Take care.

Operator

Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.

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