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NUAN > SEC Filings for NUAN > Form 10-K on 29-Nov-2012All Recent SEC Filings

Show all filings for NUANCE COMMUNICATIONS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for NUANCE COMMUNICATIONS, INC.


29-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following Management's Discussion and Analysis is intended to help the reader understand the results of operations and financial condition of our business. Management's Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes to the consolidated financial statements.

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks, uncertainties and assumptions that, if they never materialize or if they prove incorrect, could cause our consolidated results to differ materially from those expressed or implied by such forward-looking statements. These forward-looking statements include predictions regarding:

our future revenue, cost of revenue, research and development expenses, selling, general and administrative expenses, amortization of intangible assets and gross margin;

our strategy relating to our segments;


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the potential of future product releases;

our product development plans and investments in research and development;

future acquisitions, and anticipated benefits from acquisitions;

international operations and localized versions of our products; and

legal proceedings and litigation matters.

You can identify these and other forward-looking statements by the use of words such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "intends," "potential," "continue" or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks described in Item 1A - "Risk Factors" and elsewhere in this Annual Report on Form 10-K.

You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

We are a leading provider of voice and language solutions for businesses and consumers around the world. Our solutions are used in healthcare, mobile, consumer, enterprise customer service, and imaging markets. We offer market-leading accuracy, natural language understanding capability, domain knowledge and implementation capabilities, built on our significant, long-term investments in research and development. Our solutions are based on our proprietary voice and language platform and are used every day by millions of people and thousands of businesses for tasks and services such as requesting information from a phone-based self-service solution, dictating medical records, searching the mobile Web by voice, entering a destination into a navigation system, or working with PDF documents. We offer our solutions to our customers in a variety of ways, including through products, hosting, professional services and maintenance and support. Our product revenues include embedded OEM royalties, traditional enterprise licensing, term-based enterprise licensing and consumer-based sales. Our hosting revenues are primarily generated through on-demand service models, comprised of hosted transaction-based pricing arrangements that typically have multi-year terms. Our hosting and maintenance and support revenues are recurring in nature as our customers need to use our products on a repeat basis to handle their needs in medical transcription, enterprise customer service and mobile connected services. Our professional services also offer a visible revenue stream, as we have a backlog of assignments that take time to complete.

We are organized in four segments; Healthcare, Mobile and Consumer, Enterprise, and Imaging. Our solutions and services address our four segments:

Healthcare. We provide a comprehensive set of solutions and services that support the clinical documentation process from capturing the patient encounter with their physician, to improved clinical documentation, coding, compliance and reimbursement. Our hosted and on-premise solutions provide platforms to generate and distribute clinical documentation through the use of advanced dictation and transcription features, and allow us to deliver scalable, highly productive medical transcription solutions. We offer solutions that leverage the captured information and with state-of-the-art coding, compliance and record management which streamlines health information management ("HIM") processes to drive compliance and reimbursement. Through Clinical Documentation Improvement programs, we bridge the gap between physicians and coders. These solutions will significantly streamline speed and completeness of documentation so that providers can shorten the time between the patient visit and the payment for that visit. Our solutions also enable us to accelerate future innovation to transform the way healthcare providers document patient care, through improved interface with electronic medical records and extraction of clinical information to support the billing and insurance reimbursement processes. We also offer speech recognition solutions for radiology, cardiology, pathology and related specialties, that help healthcare providers dictate, edit and sign reports without manual transcription. Trends in our healthcare business include a growing customer preference for hosted solutions, increasing interest in the use of mobile devices to access healthcare systems and records, and increasing international interest. We continue to see strong demand for transactions which involve the sale and delivery of both software and non-software related services or products. Over the last several quarters, we have signed several new contracts for our hosted solutions, and the volume of lines processed in these services has steadily increased. We are investing to expand our product set to address these opportunities, expand our international capabilities, and reduce our time from contract signing to initiation of billable services.

Mobile and Consumer. Our portfolio of mobile and consumer solutions and services includes an integrated suite of


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voice control and text-to-speech solutions, dictation applications, predictive text technologies, mobile messaging services and emerging services such as dictation, Web search and voicemail-to-text. Our suite of Dragon general purpose desktop and portable computer dictation applications increases productivity by using speech to create documents, streamline repetitive and complex tasks, input data, complete forms and automate manual transcription processes. In particular, we have focused in recent quarters on integrating our Dragon technology and brand initiatives across mobile and consumer markets. Trends in our mobile-consumer segment include device manufacturers requiring custom applications to deliver unique and differentiated products, broadening keyboard technologies to take advantage of touch screens, increasing hands-free capabilities on cell phones and automobiles to address the growing concern of distracted driving, and the adoption of our technology on a broadening scope of devices, such as televisions, set-top boxes, e-book readers and tablet computers. We continue to see strong demand for transactions which involve the sale and delivery of both software and non-software related services or products. We are investing to increase our capabilities and capacity to help device manufacturers build custom applications, to increase the capacity of our data centers, to increase the number, kinds and capacity of network services, to enable developers to access our technology, and to expand both awareness and channels for our direct-to-consumer products.
Enterprise. We deliver a portfolio of customer service business intelligence and authentication solutions that are designed to help companies better support, understand and communicate with their customers. Our solutions include the use of technologies such as speech recognition, natural language understanding, text-to-speech, biometric voice recognition and analytics to automate caller identification and authorization, call steering, completion of tasks such as updates, purchases and information retrieval, and automated outbound notifications. Our solutions improve the customer experience, increase the use of self-service and enable new revenue opportunities. In addition, we offer solutions that can meet customer care needs through direct interaction with thin-client applications on cell phones, enabling customers to very quickly retrieve relevant information. Trends in our enterprise business include increasing interest in the use of mobile applications to access customer care systems and records, increasing interest in coordinating actions and data across customer care channels, and the ability of a broader set of hardware providers and systems integrators to serve the market. We are investing to expand our product set to address these opportunities, to increase efficiency of our hosted applications, expand our capabilities and capacity to help customers build custom applications, and broaden our relationships with new hardware and systems integrator partners serving the market.

Imaging. Our imaging solutions offer optical character recognition technology to deliver highly accurate document scanning and storage. We provide networked print management and comprehensive PDF applications designed specifically for business users. In addition, we offer applications that combine network scanning, network print management and PDF creation to quickly enable distribution of documents to users' desktops or to enterprise applications. Our host of services includes software development toolkits for independent software vendors. The imaging market is evolving to include more networked solutions, mobile access to networked solutions, and multi-function devices. We are investing to improve mobile access to our networked products, expand our distribution channels and embedding relationships, and expand our language coverage.

We leverage our global professional services organization and our extensive network of partners to design and deploy innovative solutions for businesses and organizations around the globe. We market and sell our products directly through a dedicated sales force and through our e-commerce website and also through a global network of resellers, including system integrators, independent software vendors, value-added resellers, hardware vendors, telecommunications carriers and distributors.

We have built a world-class portfolio of intellectual property, technologies, applications and solutions through both internal development and acquisitions. We expect to continue to pursue opportunities to broaden these assets and expand our customer base through acquisitions.

Confronted by dramatic increases in electronic information, consumers, business personnel and healthcare professionals must use a variety of resources to retrieve information, transcribe patient records, conduct transactions and perform other job-related functions. We believe that the power of our solutions can transform the way people use the Internet, telecommunications systems, electronic medical records, wireless and mobile networks and related corporate infrastructure to conduct business.

Strategy

In fiscal 2013, we will continue to focus on growth by providing market-leading, value-added solutions for our customers and partners through a broad set of technologies, service offerings and channel capabilities. We will also continue to focus on operating efficiencies, expense discipline and acquisition synergies to improve gross margins and operating margins. We intend to pursue growth through the following key elements of our strategy:

Extend Technology Leadership. Our solutions are recognized as among the best in their respective categories. We intend


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to leverage our global research and development organization and broad portfolio of technologies, applications and intellectual property to foster technological innovation and maintain customer preference for our solutions. We also intend to invest in our engineering resources and seek new technological advancements that further expand the addressable markets for our solutions.
Broaden Expertise in Vertical Markets. Businesses are increasingly turning to Nuance for comprehensive solutions rather than for a single technology product. We intend to broaden our expertise and capabilities to deliver targeted solutions for a range of industries including mobile device manufacturers, healthcare, telecommunications, financial services and government administration. We also intend to expand our global sales and professional services capabilities to help our customers and partners design, integrate and deploy innovative solutions.

Increase Subscription and Transaction Based Recurring Revenue. We intend to increase our subscription and transaction based offerings in our segments. The expansion of our subscription or transaction based solutions will enable us to deliver applications that our customers use on a repeat basis, and pay for on a per use basis, providing us with the opportunity to enjoy the benefits of recurring revenue streams.

Expand Global Presence. We intend to further expand our international resources to better serve our global customers and partners and to leverage opportunities in emerging markets such as Asia and Latin America. We continue to add regional executives and sales employees in different geographic regions to better address demand for voice and language based solutions and services.

Pursue Strategic Acquisitions and Partnerships. We have selectively pursued strategic acquisitions to expand our technology, solutions and resources to complement our organic growth. We have also formed key partnerships with other important companies in our markets of interest, and intend to continue to do so in the future where it will enhance the value of our business. We have proven experience in integrating businesses and technologies and in delivering enhanced value to our customers, partners, employees and shareholders. We intend to continue to pursue acquisitions that enhance our solutions, serve specific vertical markets and strengthen our technology portfolio.

Key Metrics

In evaluating the financial condition and operating performance of our business, management focuses on revenue, net income, gross margins, operating margins and cash flow from operations. A summary of these key financial metrics for the fiscal year ended September 30, 2012, as compared to the fiscal year ended September 30, 2011, is as follows:

Total revenue increased by $332.8 million to $1,651.5 million;

Net income improved by $168.9 million to $207.1 million;

Gross margins increased by 1.3 percentage points to 63.4%;

Operating margins increased by 3.6 percentage point to 7.6%; and

Cash provided by operating activities for the fiscal year ended September 30, 2012 was $473.0 million, an increase of $115.6 million from the prior fiscal year.

In addition to the above key financial metrics, we also focus on certain non-financial performance indicators. A summary of these key non-financial performance indicators as of and for the period ended September 30, 2012, as compared to September 30, 2011, is as follows:

Annualized line run-rate in our on-demand healthcare solutions increased 21% to approximately 4.8 billion lines per year. The annualized line run-rate is determined using billed equivalent line counts in a given quarter, multiplied by four; and

Estimated 3-year value of on-demand contracts increased 43% to approximately $1.9 billion. We determine this value by using our best estimate of all anticipated future revenue streams under signed on-demand contracts currently in place, whether or not they are guaranteed through a minimum commitment clause. Our best estimate is based on assumptions about launch dates, volumes and renewal rates within the three year period. Most of these contracts are priced by volume of usage and typically have no or low minimum commitments. Actual revenue could vary from our estimates due to factors such as cancellations, non-renewals or volume fluctuations.


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RESULTS OF OPERATIONS

Total Revenues

The following tables show total revenues by product type and revenue by
geographic location, based on the location of our customers, in dollars and
percentage change (dollars in millions):

                                                                                % Change 2012     % Change 2011
                           Fiscal 2012       Fiscal 2011       Fiscal 2010        vs. 2011          vs. 2010
Product and licensing    $       740.7     $       607.4     $       473.5          21.9 %            28.3 %
Professional services
and hosting                      674.0             509.1             463.5          32.4 %             9.8 %
Maintenance and support          236.8             202.2             181.9          17.1 %            11.2 %
Total Revenues           $     1,651.5     $     1,318.7     $     1,118.9          25.2 %            17.9 %
United States            $     1,175.2     $       963.7     $       802.0          21.9 %            20.2 %
International                    476.3             355.0             316.9          34.2 %            12.0 %
Total Revenues           $     1,651.5     $     1,318.7     $     1,118.9          25.2 %            17.9 %

Fiscal 2012 Compared to Fiscal 2011

The geographic split for fiscal 2012 was 71% of total revenue in the United States and 29% internationally, as compared to 73% of total revenue in the United States and 27% internationally for the same period last year. The increase in the proportion of revenue generated internationally was primarily due to contributions from our Mobile and Consumer and Imaging segments.

Fiscal 2011 Compared to Fiscal 2010

The geographic split for fiscal 2011 was 73% of total revenue in the United States and 27% internationally, as compared to 72% of total revenue in the United States and 28% internationally for the same period last year. The increase in the proportion of revenue generated domestically was primarily due to contributions from our Healthcare on-demand solutions, which are sold predominantly in the United States.

Product and Licensing Revenue

Product and licensing revenue primarily consists of sales and licenses of our
technology. The following table shows product and licensing revenue, in dollars
and as a percentage of total revenue (dollars in millions):
                                                                          % Change 2012     % Change 2011
                          Fiscal 2012     Fiscal 2011     Fiscal 2010       vs. 2011          vs. 2010
Product and licensing
revenue                  $     740.7     $     607.4     $     473.5          21.9 %            28.3 %
As a percentage of total
revenues                        44.9 %          46.1 %          42.3 %

Fiscal 2012 Compared to Fiscal 2011

Product and licensing revenue for fiscal 2012 increased $133.3 million, as compared to fiscal 2011. The increase consisted of a $74.6 million increase in Mobile and Consumer revenue primarily driven by growth in sales of our embedded solutions. Imaging product and licensing revenue increased $36.1 million, primarily driven by sales of our multi-functional peripheral ("MFP") products, which included revenue associated with our acquisition of Equitrac in the third quarter of fiscal 2011.

Fiscal 2011 Compared to Fiscal 2010

Product and licensing revenue for fiscal 2011 increased $133.9 million, as compared to fiscal 2010. The increase consisted of a $50.1 million increase in Mobile and Consumer revenue primarily driven by $31.6 million of growth in sales of our embedded solutions, and additional sales of $18.5 million of Dragon consumer products. Imaging revenue increased by $43.9 million, due to increased revenue from our MFP products. Healthcare revenue increased by $23.0 million resulting in part from continued strength in Dragon Medical solutions, which represented $12.8 million of the increase during the year. Enterprise on-premise license sales increased by $16.9 million resulting from the continued increase in global demand for our core speech solutions.


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Professional Services and Hosting Revenue

Professional services revenue primarily consists of consulting, implementation
and training services for customers. Hosting revenue primarily relates to
delivering hosted services, such as medical transcription, automated customer
care applications, voice message transcription, and mobile search and
transcription, over a specified term. The following table shows professional
services and hosting revenue, in dollars and as a percentage of total revenue
(dollars in millions):
                                                                          % Change 2012     % Change 2011
                          Fiscal 2012     Fiscal 2011     Fiscal 2010       vs. 2011           vs. 2010
Professional services
and hosting revenue      $     674.0     $     509.1     $     463.5          32.4 %             9.8 %
As a percentage of total
revenues                        40.8 %          38.6 %          41.4 %

Fiscal 2012 Compared to Fiscal 2011

Professional services and hosting revenue for fiscal 2012 increased $164.9 million, as compared to fiscal 2011. The increase consisted of a $130.6 million increase in Healthcare revenue primarily driven by transactional volume growth in our on-demand solutions, of which $77.4 million was due to our acquisitions closed during fiscal 2011 and 2012. Mobile and Consumer revenue increased $30.9 million, primarily attributable to a $16.0 million increase in professional services to support the implementation of our embedded handset and automotive solutions and a $13.4 million increase driven by transactional volume growth in our connected mobile services.

Fiscal 2011 Compared to Fiscal 2010

Professional services and hosting revenue for fiscal 2011 increased $45.6 million, as compared to fiscal 2010. The increase consisted of a $40.1 million increase in Healthcare revenue primarily driven by transactional volume growth in our on-demand solutions. Mobile and Consumer revenue increased $29.3 million as a result of growth of $19.2 million in our connected mobile services and growth of $10.1 million in professional services for our embedded solutions. Enterprise revenue decreased by $24.4 million, primarily due to the decline of one on-demand customer's volume.

Maintenance and Support Revenue

Maintenance and support revenue primarily consists of technical support and
maintenance services. The following table shows maintenance and support revenue,
in dollars and as a percentage of total revenue (dollars in millions):
                                                                          % Change 2012     % Change 2011
                          Fiscal 2012     Fiscal 2011     Fiscal 2010       vs. 2011          vs. 2010
Maintenance and support
revenue                  $     236.8     $     202.2     $     181.9          17.1 %            11.2 %
As a percentage of total
revenues                        14.3 %          15.3 %          16.3 %

Fiscal 2012 Compared to Fiscal 2011

Maintenance and support revenue for fiscal 2012 increased $34.6 million, as compared to fiscal 2011. The increase was driven by growth in our product and licensing sales which included a $15.8 million increase in Imaging revenue primarily due to our acquisition of Equitrac, and a $10.2 million increase in Healthcare revenue driven by growth in sales of our Dragon Medical solutions.

Fiscal 2011 Compared to Fiscal 2010

Maintenance and support revenue for fiscal 2011 increased $20.3 million, as compared to fiscal 2010. The increase was driven by growth in our product and licensing sales which included a $7.5 million increase in Healthcare driven by Dragon Medical solutions, a $5.5 million increase in Enterprise, and a $5.3 million increase in Imaging with contributions from our acquisition of Equitrac.


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                               COSTS AND EXPENSES

Cost of Product and Licensing Revenue

Cost of product and licensing revenue primarily consists of material and
fulfillment costs, manufacturing and operations costs and third-party royalty
expenses. The following table shows cost of product and licensing revenue, in
dollars and as a percentage of product and licensing revenue (dollars in
millions):
                                                                          % Change 2012     % Change 2011
                          Fiscal 2012     Fiscal 2011     Fiscal 2010       vs. 2011          vs. 2010
Cost of product and
licensing revenue        $      74.8     $      65.6     $      49.6          14.0 %            32.3 %
As a percentage of
product and licensing
revenue                         10.1 %          10.8 %          10.5 %

Fiscal 2012 Compared to Fiscal 2011

Cost of product and licensing revenue for fiscal 2012 increased $9.2 million, as compared to fiscal 2011. The increase was primarily due to a $5.0 million increase in Imaging costs driven by our acquisition of Equitrac. Gross margin increased 0.7 percentage points primarily due to a mix shift toward our Mobile embedded solutions which carry a higher gross margin.

Fiscal 2011 Compared to Fiscal 2010

Cost of product and licensing revenue for fiscal 2011 increased $16.0 million, as compared to fiscal 2010. The increase was primarily due to an increase in hardware costs associated with increased revenues from our MFP products in the Imaging segment. Gross margin remained relatively flat during the period.

Cost of Professional Services and Hosting Revenue

Cost of professional services and hosting revenue primarily consists of
compensation for services personnel, outside consultants and overhead, as well
as the hardware, infrastructure and communications fees that support our hosting
solutions. The following table shows cost of professional services and hosting
revenue, in dollars and as a percentage of professional services and hosting
revenue (dollars in millions):

                                                                          % Change 2012     % Change 2011
                          Fiscal 2012     Fiscal 2011     Fiscal 2010       vs. 2011          vs. 2010
Cost of professional
services and hosting
. . .
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