UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

Commission file number 0-27038

NUANCE COMMUNICATIONS, INC.

(Exact name of Registrant as Specified in its Charter)

 

 

Registrant’s telephone number, including area code:

(781) 565-5000

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the outstanding common equity held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $3.6 billion based upon the last reported sales price on the Nasdaq National Market for such date. For purposes of this disclosure, shares of Common Stock held by officers and directors of the Registrant and by persons who hold more than 5% of the outstanding Common Stock have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive.

 

The number of shares of the Registrant’s Common Stock, outstanding as of October 31, 2011, was 300,761,764.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement to be delivered to stockholders in connection with the Registrant’s 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 

 

NUANCE COMMUNICATIONS, INC.

 

TABLE OF CONTENTS

 

 

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. All statements other than statements of historical fact are statements that could be deemed forward-looking, including statements pertaining to: our future revenue, cost of revenue, research and development expense, selling, general and administrative expenses, amortization of intangible assets and gross margin, earnings, cash flows and liquidity; our strategy relating to our segments; 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; our contractual commitments; our fiscal 2012 revenue and expense expectations 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 as a result of various factors, including those set forth in Item 1A of this Annual Report under the heading “Risk Factors.” All forward-looking statements included in this document are based on information available to us on the date hereof. We will not undertake and specifically decline any obligation to update any forward-looking statements.

 

 

Overview

 

Nuance Communications, Inc. is a leading provider of voice and language solutions for businesses and consumers around the world. Our technologies, applications and services make the user experience more compelling by transforming the way people interact with devices and systems. Our solutions 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. Our solutions help make these interactions, tasks and experiences more productive, compelling and efficient.

 

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 expand our assets, geographic presence, distribution network and customer base through acquisitions of other businesses and technologies.

 

Effective in the fourth quarter of fiscal 2011, we are organized in four segments; Healthcare, Mobile and Consumer, Enterprise, and Imaging. In fiscal 2011, segment revenue as a percentage of total segment revenue for Healthcare, Mobile and Consumer, Enterprise and Imaging was 38%, 28%, 21% and 13%, respectively. In fiscal 2010, segment revenue as a percentage of total segment revenue for Healthcare, Mobile and Consumer, Enterprise and Imaging was 38%, 26%, 25% and 12%, respectively. See Note 22 to the consolidated financial statements for additional information about our reportable segments.

 

Healthcare

 

The healthcare industry is under significant pressure to streamline operations, reduce costs and improve patient care. In recent years, healthcare organizations such as hospitals, clinics, medical groups, physicians’ offices and

insurance providers have increasingly turned to speech recognition solutions to automate manual processes such as the dictation and transcription of patient records.

 

We provide comprehensive dictation and transcription solutions and services that automate the input and management of medical information. 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. 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.

 

We utilize a focused, enterprise sales team and professional services organization to address the market and implementation requirements of the healthcare industry. Direct distribution is supplemented by distributors and partnerships with electronic medical records application and other healthcare IT providers such as 3M, Allscripts, Cerner, Epic, GE, IBM and McKesson. In some cases, our healthcare solutions are priced under a traditional software perpetual licensing model. However, certain of our healthcare solutions, in particular our transcription solution, are also offered on an on-demand model, charged as a subscription and priced by volume of usage (such as number of lines transcribed). During fiscal 2009, 2010 and 2011, we experienced a significant shift in customer preference toward our subscription pricing model. Representative customers include Banner Health, Cleveland Clinic, Department of Veterans Affairs, HCA, Kaiser Permanente, Mayo Clinic, NHS, Sutter Health, Tenet, UPMC and U.S. Army.

 

Mobile and Consumer

 

Today, an increasing number of people worldwide rely on mobile devices to stay connected, informed and productive. We help consumers use the powerful capabilities of their phones, cars, tablets, desktop and portable computers, personal navigation devices and other consumer electronics by enabling the use of voice commands, text-to-speech and enhanced text input solutions to control and interact with these devices more easily and naturally, and to access the array of content and services available on the Internet.

 

Our portfolio of mobile and consumer solutions and services includes an integrated suite of 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. We utilize a focused, enterprise sales team and professional services organization to address market and implementation requirements. Direct distribution is supplemented by partnerships with electronics suppliers and integrators such as Harman Kardon and Clarion. Our solutions are used by mobile phone, automotive, personal navigation device, computer and other consumer electronic manufacturers and their suppliers, including Amazon, Apple, Audi, BMW, Ford, Garmin, GM, HTC, LG Electronics, Mercedes Benz, Nokia, Samsung, T-Mobile, TomTom and Toyota. Telecommunications carriers, web search companies and content providers are increasingly using our mobile search and communication solutions to offer value-added services to their subscribers and customers. Our embedded mobile solutions are sold to automobile and device manufacturers, generally on a royalty model priced per device sold, and sometimes on a license model. Our connected mobile services are sold through telecommunications carriers, voicemail system providers, smartphone application developers or directly to consumers, and generally priced on a volume of usage model (such as per subscriber or per use). Representative connected services customers and partners include AT&T, Cisco, Comcast, Rogers, Telefonica, Telstra, Time Warner Cable, TISA, T-Mobile and Vodafone. In addition, various smartphone app stores include hundreds of applications that utilize our technology, such as our DragonDictation, DragonGo! and FlexT9, as well as third party applications including Amazon Price Check, Ask, Bon’ App, iTranslate, Merriam-Webster, Vocre and Yellow Pages.

Our desktop and portable computer dictation software is currently available in seventeen languages. During the fourth quarter of fiscal 2010, we shipped new versions of Dragon NaturallySpeaking for Windows and Dragon Dictate for Mac. Our desktop and portable computer dictation solutions are generally sold under a traditional perpetual software license model. We utilize a combination of our global reseller network and direct sales to distribute our desktop and portable computer dictation products. Resellers include retailers such as Amazon, Best Buy and WalMart. Enterprise customers include organizations such as law firms, insurance agencies and government agencies. Representative customers include ATF, Exxon, FBI, IBM, Texas Department of Family Protective Services and Zurich.

 

Enterprise

 

To remain competitive, organizations must improve the quality of customer care while reducing costs and ensuring a positive customer experience. Technological innovation, competitive pressures and rapid commoditization have made it increasingly important for organizations to achieve enduring market differentiation and secure customer loyalty. In this environment, organizations need to satisfy the expectations of increasingly savvy and mobile consumers who demand high levels of customer service.

 

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. We complement our solutions and products with a global professional services organization that supports customers and partners with business and systems consulting project management, user-interface design, voice science, application development and business performance optimization, allowing us to deliver end-to-end speech solutions and system integration for voice-enabled customer care. 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. Use of our speech-enabled and thin-client customer care solutions can dramatically decrease customer care costs, in comparison to calls handled by operators.

 

Our solutions are used by a wide variety of enterprises in customer-service intensive sectors, including telecommunications, financial services, travel and entertainment, and government. Our speech solutions are designed to serve our global partners and customers and are available in approximately 60 languages and dialects worldwide. In addition to our own sales and professional services teams, we often work closely with industry partners, including Avaya, Cisco and Genesys, that integrate our solutions into their hardware and software platforms. Our enterprise solutions offerings include both a traditional software perpetual licensing model and an on-demand model, charged as a subscription and priced by volume of usage (such as number of minutes callers use the system or number of calls completed in the system). Representative customers include Bank of America, Cigna, Citibank, Disney, FedEx, Onstar, US Airways and Wells Fargo.

 

Imaging

 

The evolution of the Internet, email and other networks has greatly simplified the ability to share electronic documents, resulting in an ever-growing volume of documents to be used and stored. In addition, the proliferation of network and Internet connected multifunction printers has increased the need to efficiently manage printers and enforce printing policies. Our document imaging, print management and PDF solutions reduce the costs associated with paper documents through easy to use scanning, document management and electronic document routing solutions. We offer versions of our products to multifunction printer manufacturers, home offices, small businesses and enterprise customers.

 

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. Our

imaging solutions are generally sold under a traditional perpetual software license model, and some solutions are also offered as a hosted solution. We utilize a combination of our global reseller network and direct sales to distribute our imaging products. We license our software to multifunction printer manufacturers such as Brother, Canon, Dell, HP and Xerox, which bundle our solutions with multi-function devices, digital copiers, printers and scanners, on a royalty model, priced per unit sold.

 

Research and Development/Intellectual Property

 

In recent years, we have developed and acquired extensive technology assets, intellectual property and industry expertise in voice, language and imaging that provide us with a competitive advantage in our markets. Our technologies are based on complex algorithms which require extensive amounts of linguistic and image data, acoustic models and recognition techniques. A significant investment in capital and time would be necessary to replicate our current capabilities.

 

We continue to invest in technologies to maintain our market-leading position and to develop new applications. Our technologies are covered by approximately 2,300 patents and 1,500 patent applications. Our intellectual property, whether purchased or developed internally, is critical to our success and competitive position and, ultimately, to our market value. We rely on a portfolio of patents, copyrights, trademarks, services marks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our intellectual property and proprietary rights. We incurred research and development expenses of $179.4 million, $152.1 million, and $116.8 million in fiscal 2011, 2010 and 2009, respectively.

 

International Operations

 

We have principal offices in a number of international locations including: Australia, Belgium, Canada, Germany, Hungary, India, Italy, Japan, and the United Kingdom. The responsibilities of our international operations include research and development, healthcare transcription and editing, customer support, sales and marketing and administration. Additionally, we maintain smaller sales, services and support offices throughout the world to support our international customers and to expand international revenue opportunities.

 

Geographic revenue classification is based on the geographic areas in which our customers are located. For fiscal 2011, 2010 and 2009, 73%, 72% and 74% of revenue was generated in the United States and 27%, 28% and 26% of revenue was generated by our international operations, respectively.

 

Competition

 

The individual markets in which we compete are highly competitive and are subject to rapid technology changes. There are a number of companies that develop or may develop products that compete in our target markets; however, currently there is no one company that competes with us in all of our product areas. While we expect competition to continue to increase both from existing competitors and new market entrants, we believe that we will compete effectively based on many factors, including:

 

 

 

In our segments, we compete with companies such as Adobe, Medquist, Microsoft and Google. In addition, a number of smaller companies in both speech and imaging offer services, technologies or products that are competitive with our solutions in some markets. In certain markets, some of our partners such as Avaya, Cisco, Intervoice and Genesys develop and market products and services that might be considered substitutes for our solutions. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of our prospective customers.

 

Some of our competitors or potential competitors, such as Adobe, Microsoft and Google, have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do.

 

Employees

 

As of September 30, 2011, we had approximately 7,300 full-time employees in total, including approximately 900 in sales and marketing, approximately 1,750 in professional services, approximately 1,200 in research and development, approximately 550 in general and administrative and approximately 2,900 that provide transcription and editing services. Approximately 43 percent of our employees are based outside of the United States, the majority of whom provide transcription and editing services and are based in India. Our employees are not represented by any labor union and are not organized under a collective bargaining agreement, and we have never experienced a work stoppage. We believe that our relationships with our employees are generally good.

 

Company Information

 

We were incorporated in 1992 as Visioneer, Inc. under the laws of the state of Delaware. In 1999, we changed our name to ScanSoft, Inc. and also changed our ticker symbol to SSFT. In October 2005, we changed our name to Nuance Communications, Inc. and in November 2005 we changed our ticker symbol to NUAN.

 

Our website is located at www.nuance.com. This Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and all amendments to these reports, as well as proxy statements and other information we file with or furnish to the Securities and Exchange Commission, or the SEC, are accessible free of charge on our website. We make these documents available as soon as reasonably practicable after we file them with, or furnish them to, the SEC. Our SEC filings are also available on the SEC’s website at http://www.sec.gov. Alternatively, you may access any document we have filed by visiting the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Except as otherwise stated in these documents, the information contained on our website or available by hyperlink from our website is not incorporated by reference into this report or any other documents we file with or furnish to the SEC.

 

 

You should carefully consider the risks described below when evaluating our company and when deciding whether to invest in our company. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we do not currently believe are important to an investor may also harm our business operations. If any of the events, contingencies, circumstances or conditions described in the following risks actually occurs, our business, financial condition or our results of operations could

be seriously harmed. If that happens, the trading price of our common stock could decline and you may lose part or all of the value of any of our shares held by you.

 

Risks Related to Our Business

 

Our operating results may fluctuate significantly from period to period, and this may cause our stock price to decline.

 

Our revenue and operating results have fluctuated in the past and are expected to continue to fluctuate in the future. Given this fluctuation, we believe that quarter to quarter comparisons of revenue and operating results are not necessarily meaningful or an accurate indicator of our future performance. As a result, our results of operations may not meet the expectations of securities analysts or investors in the future. If this occurs, the price of our stock would likely decline. Factors that contribute to fluctuations in operating results include the following:

 

 

Due to the foregoing factors, among others, our revenue and operating results are difficult to forecast. Our expense levels are based in significant part on our expectations of future revenue and we may not be able to reduce our expenses quickly to respond to a shortfall in projected revenue. Therefore, our failure to meet revenue expectations would seriously harm our operating results, financial condition and cash flows.

 

We have grown, and may continue to grow, through acquisitions, which could dilute our existing stockholders.

 

As part of our business strategy, we have in the past acquired, and expect to continue to acquire, other businesses and technologies. In connection with past acquisitions, we issued a substantial number of shares of our common stock as transaction consideration and also incurred significant debt to finance the cash consideration used for our acquisitions. We may continue to issue equity securities for future acquisitions, which would dilute existing stockholders, perhaps significantly depending on the terms of such acquisitions. We may also incur additional debt in connection with future acquisitions, which, if available at all, may place additional restrictions on our ability to operate our business.

Our ability to realize the anticipated benefits of our acquisitions will depend on successfully integrating the acquired businesses.

 

Our prior acquisitions required, and our recently completed acquisitions continue to require, substantial integration and management efforts and we expect future acquisitions to require similar efforts. Acquisitions of this nature involve a number of risks, including:

 

 

As a result of these and other risks, if we are unable to successfully integrate acquired businesses, we may not realize the anticipated benefits from our acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses and technologies could seriously harm our business.

 

Charges to earnings as a result of our acquisitions may adversely affect our operating results in the foreseeable future, which could have a material and adverse effect on the market value of our common stock.

 

Under accounting principles generally accepted in the United States of America, we record the market value of our common stock or other form of consideration issued in connection with an acquisition as the cost of acquiring the company or business. We have allocated that cost to the individual assets acquired and liabilities assumed, including various identifiable intangible assets such as acquired technology, acquired trade names and acquired customer relationships based on their respective fair values. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain. After we complete an acquisition, the following factors could result in material charges and adversely affect our operating results and may adversely affect our cash flows:

 

 

 

Intangible assets are generally amortized over a five to fifteen year period. Goodwill and certain intangible assets with indefinite lives, are not subject to amortization but are subject to an impairment analysis, at least annually, which may result in an impairment charge if the carrying value exceeds its implied fair value. As of September 30, 2011, we had identified intangible assets of approximately $731.6 million, net of accumulated amortization, and goodwill of approximately $2.3 billion. In addition, purchase accounting limits our ability to recognize certain revenue that otherwise would have been recognized by the acquired company as an independent business. As a result, the combined company may delay revenue recognition or recognize less revenue than we and the acquired company would have recognized as independent companies.

 

Our significant debt could adversely affect our financial health and prevent us from fulfilling our obligations under our credit facility and our convertible debentures.

 

We have a significant amount of debt. As of September 30, 2011, we had a total of $887.4 million of gross debt outstanding, including $145.0 million in term loans due in March 2013, $492.0 million in term loans due in March 2016 under an amended and restated agreement signed in July 2011, and $250.0 million in convertible debentures. Investors may require us to redeem the convertible debentures in August 2014, or sooner if our common stock price exceeds the conversion price of approximately $23.36 for certain specified periods. We also have a $75.0 million revolving credit line available to us through March 2015. As of September 30, 2011, there were $15.4 million of letters of credit issued but there were no other outstanding borrowings under the revolving credit line. Additionally, on October 24, 2011, we sold $690.0 million of 2.75% convertible debentures which investors may require us to redeem in November 2017. Our debt level could have important consequences, for example it could:

 

 

Our ability to meet our payment and other obligations under our debt instruments depends on our ability to generate significant cash flow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, or that additional capital will be available to us, in an amount sufficient to enable us to meet our payment obligations under the convertible debentures and our other debt and to fund other liquidity needs. If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, including the convertible debentures, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the convertible debentures and our other debt.

 

In addition, a substantial portion of our debt bears interest at variable rates. If market interest rates increase, our debt service requirements will increase, which would adversely affect our results of operations and cash flows.

Our debt agreements contain covenant restrictions that may limit our ability to operate our business.

 

The agreement governing our senior credit facility contains, and any of our other future debt agreements may contain, covenant restrictions that limit our ability to operate our business, including restrictions on our ability to:

 

 

Our ability to comply with these covenants is dependent on our future performance, which will be subject to many factors, some of which are beyond our control, including prevailing economic conditions. As a result of these covenants, our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be significantly restricted, and we may be prevented from engaging in transactions that might otherwise be beneficial to us. In addition, our failure to comply with these covenants could result in a default under our debt agreements, which could permit the holders to accelerate our obligation to repay the debt. If any of our debt is accelerated, we may not have sufficient funds available to repay the accelerated debt.

 

We have a history of operating losses, and may incur losses in the future, which may require us to raise additional capital on unfavorable terms.

 

We reported net income of $38.2 million in fiscal 2011, however we reported net losses of $19.1 million and $19.4 million for the fiscal years 2010 and 2009, respectively. If we are unable to maintain profitability, the market price for our stock may decline, perhaps substantially. We cannot assure you that our revenue will grow or that we will maintain profitability in the future. If we do not achieve and maintain profitability, we may be required to raise additional capital to maintain or grow our operations. Additional capital, if available at all, may be highly dilutive to existing investors or contain other unfavorable terms, such as a high interest rate and restrictive covenants.

 

Voice and language technologies may not continue to garner widespread acceptance, which could limit our ability to grow our voice and language business.

 

We have invested and expect to continue to invest heavily in the acquisition, development and marketing of voice and language technologies. The market for voice and language technologies is relatively new and rapidly evolving. Our ability to increase revenue in the future depends in large measure on the continuing acceptance of these technologies in general and our products in particular. The continued development of the market for our current and future voice and language solutions in general, and our solutions in particular, will also depend on:

 

 

Sales of our voice and language products would be harmed if the market for these technologies does not continue to increase or increases slower than we expect, or if we fail to develop new technology faster than our competitors, and consequently, our business could be harmed and we may not achieve a level of profitability necessary to successfully operate our business.

The markets in which we operate are highly competitive and rapidly changing and we may be unable to compete successfully.

 

There are a number of companies that develop or may develop products that compete in our targeted markets. The individual markets in which we compete are highly competitive, and are rapidly changing. Within voice and language, we compete with AT&T, Microsoft, Google, and other smaller providers. Within healthcare, we compete with Medquist and other smaller providers. Within imaging, we compete with ABBYY, Adobe, I.R.I.S. and NewSoft. In voice and language, some of our partners such as Avaya, Cisco, Intervoice and Genesys develop and market products that can be considered substitutes for our solutions. In addition, a number of smaller companies in voice, language and imaging produce technologies or products that are in some markets competitive with our solutions. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of our prospective customers.

 

The competition in these markets could adversely affect our operating results by reducing the volume of the products we license or the prices we can charge. Some of our current or potential competitors, such as Adobe, Microsoft and Google, have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do.

 

Some of our customers, such as Microsoft and Google, have developed or acquired products or technologies that compete with our products and technologies. These customers may give higher priority to the sale of these competitive products or technologies. To the extent they do so, market acceptance and penetration of our products, and therefore our revenue, may be adversely affected. Our success will depend substantially upon our ability to enhance our products and technologies and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and incorporate technological enhancements. If we are unable to develop new products and enhance functionalities or technologies to adapt to these changes, or if we are unable to realize synergies among our acquired products and technologies, our business will suffer.

 

The failure to successfully maintain the adequacy of our system of internal control over financial reporting could have a material adverse impact on our ability to report our financial results in an accurate and timely manner.

 

The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contains an assessment by management of the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Any failure in the effectiveness of our system of internal control over financial reporting could have a material adverse impact on our ability to report our financial statements in an accurate and timely manner, could subject us to regulatory actions, civil or criminal penalties, shareholder litigation, or loss of customer confidence, which could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.

 

A significant portion of our revenue is derived, and a significant portion of our research and development activities are based, outside the United States. Our results could be harmed by economic, political, regulatory and other risks associated with these international regions.

 

Because we operate worldwide, our business is subject to risks associated with doing business internationally. We anticipate that revenue from international operations could increase in the future. Most of our international revenue is generated by sales in Europe and Asia. In addition, some of our products are developed and manufactured outside the United States and we have a large number of employees in India that provide transcription services. We also have a large number of employees in Canada and United Kingdom that provide professional services. A significant portion of the development and manufacturing of our voice and language products is conducted in

Belgium and Canada, and a significant portion of our imaging research and development is conducted in Hungary. We also have significant research and development resources in Austria, Germany, Italy, and United Kingdom. Accordingly, our future results could be harmed by a variety of factors associated with international sales and operations, including:

 

 

We are exposed to fluctuations in foreign currency exchange rates.

 

Because we have international subsidiaries and distributors that operate and sell our products outside the United States, we are exposed to the risk of changes in foreign currency exchange rates. In certain circumstances, we have entered into forward exchange contracts to hedge against foreign currency fluctuations. We use these contracts to reduce our risk associated with exchange rate movements, as the gains or losses on these contracts are intended to offset any exchange rate losses or gains on the hedged transaction. We do not engage in foreign currency speculation. With our increased international presence in a number of geographic locations and with international revenue and costs projected to increase, we are exposed to changes in foreign currencies including the euro, British pound, Canadian dollar, Japanese yen, Indian rupee, Australian dollar, Israel shekel, Swiss franc and the Hungarian forint. Changes in the value of foreign currencies relative to the value of the U.S. dollar could adversely affect future revenue and operating results.

 

Impairment of our intangible assets could result in significant charges that would adversely impact our future operating results.

 

We have significant intangible assets, including goodwill and intangibles with indefinite lives, which are susceptible to valuation adjustments as a result of changes in various factors or conditions. The most significant intangible assets are patents and core technology, completed technology, customer relationships and trademarks. Customer relationships are amortized on an accelerated basis based upon the pattern in which the economic benefits of customer relationships are being utilized. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. We assess the potential impairment of intangible assets on an annual basis, as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that could trigger an impairment of such assets, include the following:

 

 

Future adverse changes in these or other unforeseeable factors could result in an impairment charge that would impact our results of operations and financial position in the reporting period identified.

 

Our sales to government clients subject us to risks, including early termination, audits, investigations, sanctions and penalties.

 

We derive a portion of our revenues from contracts with the United States government, as well as various state and local governments, and their respective agencies. Government contracts are generally subject to audits and investigations which could identify violations of these agreements. Government contract violations could result in a range of consequences including, but not limited to, contract price adjustments, civil and criminal penalties, contract termination, forfeiture of profit and/or suspension of payment, and suspension or debarment from future government contracts. We could also suffer serious harm to our reputation if we were found to have violated the terms of our government contracts.

 

We conducted an analysis of our compliance with the terms and conditions of certain contracts with the U.S. General Services Administration (“GSA”). Based upon our analysis, we voluntarily notified GSA of non-compliance with the terms of two contracts. The final resolution of this matter may adversely impact our financial position.

 

If we are unable to attract and retain key personnel, our business could be harmed.

 

If any of our key employees were to leave, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any successor obtains the necessary training and experience. Our employment relationships are generally at-will and we have had key employees leave in the past. We cannot assure you that one or more key employees will not leave in the future. We intend to continue to hire additional highly qualified personnel, including software engineers and operational personnel, but may not be able to attract, assimilate or retain qualified personnel in the future. Any failure to attract, integrate, motivate and retain these employees could harm our business.

 

Our medical transcription services may be subject to legal claims for failure to comply with laws governing the confidentiality of medical records.

 

Healthcare professionals who use our medical transcription services deliver to us health information about their patients including information that constitutes a record under applicable law that we may store on our computer systems. Numerous federal and state laws and regulations, the common law and contractual obligations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including:

 

 

The Health Insurance Portability and Accountability Act of 1996 establishes elements including, but not limited to, federal privacy and security standards for the use and protection of protected health information. Any failure by us or by our personnel or partners to comply with applicable requirements may result in a material liability. Although we have systems and policies in place for safeguarding protected health information from unauthorized disclosure, these systems and policies may not preclude claims against us for alleged violations of applicable requirements. There can be no assurance that we will not be subject to liability claims that could have a material adverse affect on our business, results of operations and financial condition.

Adverse changes in general economic or political conditions in any of the major countries in which we do business could adversely affect our operating results.

 

Adverse changes in domestic and global economic and political conditions, as well as uncertainty in the global financial markets may negatively affect our financial results. These macroeconomic developments could negatively affect our business, operating results or financial condition in a number of ways which, in turn, could adversely affect our stock price. A prolonged period of economic decline could have a material adverse effect on our results of operations and financial condition and exacerbate some of the other risk factors described herein. Our customers may defer purchases of our products, licenses, and services in response to tighter credit and negative financial news or reduce their demand for them. Our customers may also not be able to obtain adequate access to credit, which could affect their ability to make timely payments to us or ultimately cause the customer to file for protection from creditors under applicable insolvency or bankruptcy laws. If our customers are not able to make timely payments to us, our accounts receivable could increase. Political instability in any of the major countries in which we do business would also likely harm our business, results of operations and financial condition.

 

Current uncertainty in the global financial markets and the global economy may negatively affect our financial results.

 

Our investment portfolio, which includes short-term debt securities, is generally subject to credit, liquidity, counterparty, market and interest rate risks that may be exacerbated by the recent global financial crisis. If the banking system or the fixed income, credit or equity markets deteriorate or remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected.

 

In addition, our operating results and financial condition could be negatively affected if, as a result of economic conditions, either:

 

 

Security and privacy breaches in our systems may damage client relations and inhibit our growth.

 

The uninterrupted operation of our hosted solutions and the confidentiality and security of third-party information is critical to our business. Any failures in our security and privacy measures could have a material adverse effect on our financial position and results of operations. If we are unable to protect, or our clients perceive that we are unable to protect, the security and privacy of our electronic information, our growth could be materially adversely affected. A security or privacy breach may:

 

 

While we believe we use proven applications designed for data security and integrity to process electronic transactions, there can be no assurance that our use of these applications will be sufficient to address changing market conditions or the security and privacy concerns of existing and potential clients.

 

Risks Related to Our Intellectual Property and Technology

 

Unauthorized use of our proprietary technology and intellectual property could adversely affect our business and results of operations.

 

Our success and competitive position depend in large part on our ability to obtain and maintain intellectual property rights protecting our products and services. We rely on a combination of patents, copyrights, trademarks,

service marks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our intellectual property and proprietary rights. Unauthorized parties may attempt to copy aspects of our products or to obtain, license, sell or otherwise use information that we regard as proprietary. Policing unauthorized use of our products is difficult and we may not be able to protect our technology from unauthorized use. Additionally, our competitors may independently develop technologies that are substantially the same or superior to our technologies and that do not infringe our rights. In these cases, we would be unable to prevent our competitors from selling or licensing these similar or superior technologies. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. Although the source code for our proprietary software is protected both as a trade secret and as a copyrighted work, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation, regardless of the outcome, can be very expensive and can divert management efforts.

 

Third parties have claimed and may claim in the future that we are infringing their intellectual property, and we could be exposed to significant litigation or licensing expenses or be prevented from selling our products if such claims are successful.

 

From time to time, we are subject to claims that we or our customers may be infringing or contributing to the infringement of the intellectual property rights of others. We may be unaware of intellectual property rights of others that may cover some of our technologies and products. If it appears necessary or desirable, we may seek licenses for these intellectual property rights. However, we may not be able to obtain licenses from some or all claimants, the terms of any offered licenses may not be acceptable to us, and we may not be able to resolve disputes without litigation. Any litigation regarding intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. In the event of a claim of intellectual property infringement, we may be required to enter into costly royalty or license agreements. Third parties claiming intellectual property infringement may be able to obtain injunctive or other equitable relief that could effectively block our ability to develop and sell our products.

 

We may incur substantial costs enforcing or acquiring intellectual property rights and defending against third-party claims as a result of litigation or other proceedings.

 

In connection with the enforcement of our own intellectual property rights, the acquisition of third-party intellectual property rights, or disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been, are currently, and may in the future be, subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation are typically very costly and can be disruptive to our business operations by diverting the attention and energy of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. In addition, we may incur significant costs in acquiring the necessary third party intellectual property rights for use in our products. Third party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from manufacturing or licensing certain of our products, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements. Any of these could seriously harm our business.

 

Our software products may have bugs, which could result in delayed or lost revenue, expensive correction, liability to our customers and claims against us.

 

Complex software products such as ours may contain errors, defects or bugs. Defects in the solutions or products that we develop and sell to our customers could require expensive corrections and result in delayed or lost revenue, adverse customer reaction and negative publicity about us or our products and services. Customers who are not satisfied with any of our products may also bring claims against us for damages, which, even if unsuccessful, would likely be time-consuming to defend, and could result in costly litigation and payment of damages. Such claims could harm our reputation, financial results and competitive position.

Risks Related to our Corporate Structure, Organization and Common Stock

 

The holdings of our largest stockholder may enable it to influence matters requiring stockholder approval.

 

As of September 30, 2011, Warburg Pincus, a global private equity firm, beneficially owned approximately 23% of our outstanding common stock, including warrants exercisable for up to 7,562,422 shares of our common stock, and 3,562,238 shares of our outstanding Series B Preferred Stock, each of which is convertible into one share of our common stock. Because of its large holdings of our capital stock relative to other stockholders, this stockholder has a strong influence over matters requiring approval by our stockholders.

 

The market price of our common stock has been and may continue to be subject to wide fluctuations, and this may make it difficult for you to resell the common stock when you want or at prices you find attractive.

 

Our stock price historically has been, and may continue to be, volatile. Various factors contribute to the volatility of our stock price, including, for example, quarterly variations in our financial results, new product introductions by us or our competitors and general economic and market conditions. Sales of a substantial number of shares of our common stock by our largest stockholders, or the perception that such sales could occur, could also contribute to the volatility or our stock price. While we cannot predict the individual effect that these factors may have on the market price of our common stock, these factors, either individually or in the aggregate, could result in significant volatility in our stock price during any given period of time. Moreover, companies that have experienced volatility in the market price of their stock often are subject to securities class action litigation. If we were the subject of such litigation, it could result in substantial costs and divert management’s attention and resources.

 

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

 

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, new regulations promulgated by the Securities and Exchange Commission and the rules of the Nasdaq Marketplace, are resulting in increased general and administrative expenses for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies, our business may be harmed.

 

Future sales of our common stock in the public market could adversely affect the trading price of our common stock and our ability to raise funds in new stock offerings.

 

Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings of equity or equity-related securities. In connection with past acquisitions, we issued a substantial number of shares of our common stock as transaction consideration. We may continue to issue equity securities for future acquisitions, which would dilute existing stockholders, perhaps significantly depending on the terms of such acquisitions. No prediction can be made as to the effect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future sale, will have on the trading price of our common stock.

We have implemented anti-takeover provisions, which could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.

 

Provisions of our certificate of incorporation, bylaws and Delaware law, as well as other organizational documents could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include:

 

 

 

None.

 

Our corporate headquarters and administrative, sales, marketing, research and development and customer support functions occupy approximately 201,000 square feet of space that we lease in Burlington, Massachusetts. We also lease additional properties in the United States and a number of foreign countries. The following table summarizes our significant properties as of September 30, 2011:

 

 

 

 

In addition to the properties referenced above, we also lease a number of small sales and marketing offices in the United States and internationally. As of September 30, 2011, we were productively utilizing substantially all of the space in our facilities, except for space identified above as unoccupied, or that has been subleased to third parties.

 

 

Like many companies in the software industry, we have from time to time been notified of claims that we may be infringing certain intellectual property rights of others. These claims have been referred to counsel, and they are in various stages of evaluation and negotiation. If it appears necessary or desirable, we may seek licenses for these intellectual property rights. There is no assurance that licenses will be offered by all claimants, that the terms of any

offered licenses will be acceptable to us or that in all cases the dispute will be resolved without litigation, which may be time consuming and expensive, and may result in injunctive relief or the payment of damages by us.

 

PART II

 

 

Market Information

 

Our common stock is traded on the NASDAQ Global Select Market under the symbol “NUAN”. The following table sets forth, for our fiscal quarters indicated, the high and low sales prices of our common stock, in each case as reported on the NASDAQ Global Select Market.

 

 

Holders

 

As of October 31, 2011, there were 791 stockholders of record of our common stock.

 

Dividend Policy

 

We have never declared or paid any cash dividends on our common stock. We currently expect to retain future earnings, if any, to finance the growth and development of our business and do not anticipate paying any cash dividends in the foreseeable future. Furthermore, the terms of our credit facility place restrictions on our ability to pay dividends, except for stock dividends.

 

Issuer Purchases of Equity Securities

 

We have not announced any currently effective authorization to repurchase shares of our common stock. We did, however, repurchase 8,514,120 shares of our common stock for $200 million in connection with our sale of $690 million of 2.75% convertible debentures in October 2011.

 

The following selected consolidated financial data is not necessarily indicative of the results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K (as adjusted for the retrospective application of FASB ASC 470-20 in 2009, 2008 and 2007).

 

 

 

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:

 

 

 

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

 

Nuance Communications, Inc. is a leading provider of voice and language solutions for businesses and consumers around the world. Our technologies, applications and services make the user experience more compelling by transforming the way people interact with devices and systems. Our solutions 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. Our solutions help make these interactions, tasks and experiences more productive, compelling and efficient.

 

Effective in the fourth quarter of fiscal 2011, we are organized in four segments; Healthcare, Mobile and Consumer, Enterprise, and Imaging. Our solutions and services address our four segments:

 

 

 

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 2012, 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:

 

 

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, 2011, as compared to the fiscal year ended September 30, 2010, is as follows:

 

 

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, 2011, as compared to September 30, 2010, is as follows:

 

 

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):

 

 

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.

 

Fiscal 2010 Compared to Fiscal 2009

 

The geographic split for fiscal 2010 was 72% of total revenue in the United States and 28% internationally, as compared to 74% of total revenue in the United States and 26% internationally for the same period last year. The increase in the proportion of revenue generated internationally was primarily due to contributions from our acquisition of PSRS near the end of fiscal 2008.

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):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in product and licensing revenue for fiscal 2011, as compared to fiscal 2010, 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 products. Imaging revenue increased by $43.9 million, due to increased revenue from our multi-functional peripheral (“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. The growth in our product and licensing revenue streams outpaced the relative growth of our other revenue types, resulting in the 3.8 percentage point increase as a percent of total revenue.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in product and licensing revenue for fiscal 2010, as compared to fiscal 2009, consisted of a $57.8 million increase in Mobile and Consumer revenue primarily driven by $43.5 million of growth in sales of our embedded solutions, and a $14.4 million growth in sales of our Dragon product resulting from our fourth quarter launch of Dragon Naturally Speaking 11. Healthcare revenue increased by $37.7 million. Imaging revenue increased $9.8 million primarily as a result of our acquisitions of eCopy and X-Solutions in fiscal 2009. Enterprise revenue decreased $5.3 million primarily due to the continued migration of customers to our on-demand solutions. The growth in our product and licensing revenue streams outpaced the relative growth of our other revenue types, resulting in the 3.0 percentage point increase as a percent of total revenue.

 

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):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in professional services and hosting revenue for fiscal 2011, as compared to fiscal 2010, 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. As a percentage of total revenue, professional services and hosting revenue decreased 2.8 percentage points as compared to the corresponding period in the prior year, primarily due to the strong growth in the product and licensing revenue relative to professional services and hosting revenue.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in professional services and hosting revenue for fiscal 2010, as compared to fiscal 2009, consisted of a $31.8 million increase in Healthcare revenue resulting largely from transactional volume growth in our on-demand solutions. Mobile and Consumer revenue increased $28.5 million primarily due to contributions from our connected mobile services driven by the acquisition of SpinVox in December 2009. Enterprise revenue decreased by $9.4 million. As a percentage of total revenue, professional services and hosting revenue decreased 1.9 percentage points as compared to the corresponding period in the prior year, primarily due to the strong growth in the product and licensing revenue relative to professional services and hosting revenue.

 

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):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in maintenance and support revenue for fiscal 2011, as compared to fiscal 2010, was driven by growth in our product and licensing sales. The increase 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.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in maintenance and support revenue for fiscal 2010, as compared to fiscal 2009, consisted primarily of a $6.4 million increase in Enterprise revenue, driven by continued organic growth, a $5.6 million increase in Healthcare revenue as a result of the expansion of our current installed base and a $2.4 million increase in Imaging revenue primarily due to contributions from growth in sales of our core imaging products and our acquisition of X-Solutions.

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):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in cost of product and licensing revenue for fiscal 2011, as compared to fiscal 2010, 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.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in cost of product and licensing revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a $3.1 million increase in Mobile and Consumer costs driven primarily by revenue growth in Dragon products resulting from our fourth quarter launch of Dragon NaturallySpeaking 11, as well a $4.6 million increase in Healthcare costs primarily related to increased sales of Dragon Medical. The cost of product and licensing revenue also increased as a result of a $2.3 million increase in Imaging costs related to our eCopy acquisition and a $2.4 million increase in Enterprise costs. 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 consulting personnel, outside consultants and overhead, as well as the hardware 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):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in cost of professional services and hosting revenue for fiscal 2011, as compared to fiscal 2010, was due to a $29.6 million increase in Healthcare costs primarily related to growth in our on-demand solutions, and a $16.8 million increase in stock-based compensation related to our professional services personnel. Gross margin relative to our professional services and hosting revenue decreased 6.4 percentage points primarily due to increased stock-based compensation expense reducing gross margin by 3.3 percentage points and the remainder is primarily related to volume and revenue declines from one on-demand Enterprise customer.

Fiscal 2010 Compared to Fiscal 2009

 

The increase in cost of professional services and hosting revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a $35.9 million increase in Mobile and Consumer costs driven by growth in our connected mobile services, a $1.5 million increase in Healthcare and a $1.4 million increase in Imaging costs driven by our eCopy acquisition. These increases are partially offset by a $12.8 million decrease in Enterprise costs. Gross margin relative to our professional services and hosting revenue increased 1.3 percentage points primarily due to growth in our higher margin healthcare on-demand business and improved professional services utilization rates.

 

Cost of Maintenance and Support Revenue

 

Cost of maintenance and support revenue primarily consists of compensation for product support personnel and overhead. The following table shows cost of maintenance and support revenue, in dollars and as a percentage of maintenance and support revenue (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in cost of maintenance and support revenue for fiscal 2011, as compared to fiscal 2010, included $2.5 million increase in costs due to higher volumes of Enterprise application maintenance and support, a $2.1 million increase in costs related to increased revenue from our MFP products in our Imaging business, which included the impact from our acquisition of Equitrac, and a $1.4 million increase in stock-based compensation expense. The increase in stock-based compensation expense reduced gross margin by 0.7% during the period. Excluding impact from stock-based compensation, gross margin remained relatively flat during the period.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in cost of maintenance and support revenue for fiscal 2010, as compared to fiscal 2009, was primarily due to a $1.8 million increase in Imaging costs as a result of our eCopy and X-solutions acquisitions. Gross margin relative to our maintenance and support revenue remained relatively constant during the period.

 

Research and Development Expense

 

Research and development expense primarily consists of salaries, benefits and overhead relating to engineering staff. The following table shows research and development expense, in dollars and as a percentage of total revenue (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in research and development expense for fiscal 2011, as compared to fiscal 2010, was attributable to a $28.6 million increase in compensation expense. The increase in compensation expense was driven by a $14.9 million increase in stock-based compensation expense and headcount growth as we continue to invest in our research and development organization as well as additional headcount from our acquisitions during the period. The

increase was offset by reimbursement of $5.9 million under a new collaboration agreement signed during the period as discussed in Note 2 to the audited consolidated financial statements.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in research and development expense for fiscal 2010, as compared to fiscal 2009, primarily consisted of a $16.7 million increase in services from a third party related to the research collaboration agreements discussed in Note 2 to the audited consolidated financial statements, a $16.5 million increase in compensation expenses attributable to the additional headcount and other resources from our acquisitions during the period, and a $2.9 million increase in infrastructure investment to support ongoing research and development projects.

 

Sales and Marketing Expense

 

Sales and marketing expense includes salaries and benefits, commissions, advertising, direct mail, public relations, tradeshow costs and other costs of marketing programs, travel expenses associated with our sales organization and overhead. The following table shows sales and marketing expense, in dollars and as a percentage of total revenue (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in sales and marketing expense for fiscal 2011, as compared to fiscal 2010, was primarily attributable to a $21.7 million increase in compensation expense. The increase in expense was driven primarily by additional headcount to support growth and a $5.1 million increase in stock-based compensation expense. Additionally, marketing and channel program spending increased $14.0 million to drive overall revenue growth.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in sales and marketing expense for fiscal 2010, as compared to fiscal 2009, was primarily attributable to a $35.4 million increase in compensation, including an $11.1 million increase in stock-based compensation expense driven primarily by the increase in grant values resulting from increase in our stock price, and other variable costs such as commissions and travel expenses. An $8.0 million increase in marketing program spending, including marketing communications and channel programs, related to new products launched during the fourth quarter of fiscal 2010.

 

General and Administrative Expense

 

General and administrative expense primarily consists of personnel costs for administration, finance, human resources, information systems, facilities and general management, fees for external professional advisors including accountants and attorneys, insurance, and provisions for doubtful accounts. The following table shows general and administrative expense, in dollars and as a percentage of total revenue (dollars in millions):

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in general and administrative expense for fiscal 2011, as compared to fiscal 2010, was primarily attributable to a $14.5 million increase in compensation expense and a $9.1 million increase in legal costs associated with on-going litigation and intellectual property maintenance. The increase in compensation expense was driven primarily by additional headcount due to operational growth and our acquisitions during the period and an $8.9 million increase in stock-based compensation expense.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in general and administrative expense for fiscal 2010, as compared to fiscal 2009, was primarily attributable to $16.9 million increase in compensation driven primarily by increase in stock-based compensation grant values resulting from the increase in our stock price, $2.3 million increase in other compensation expense and a $2.8 million increase in legal costs associated with on-going litigation and intellectual property maintenance. This increase is partially offset by a reduction of $3.0 million in temporary employees and professional services as a result of cost containment efforts and acquisition related synergies.

 

Amortization of Intangible Assets

 

Amortization of acquired patents and core and completed technology are included in cost of revenue and the amortization of acquired customer and contractual relationships, non-compete agreements, acquired trade names and trademarks, and other intangibles are included in operating expenses. Customer relationships are amortized on an accelerated basis based upon the pattern in which the economic benefits of the customer relationships are being realized. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortization expense was recorded as follows (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The increase in amortization of intangible assets for fiscal 2011, as compared to fiscal 2010, was primarily attributable to the amortization of acquired technology and patent intangible assets from our business acquisitions during fiscal 2011 and our acquisitions of patents and technology from third-parties during the fiscal 2010.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in amortization of intangible assets for fiscal 2010, as compared to fiscal 2009, was primarily attributable to the amortization of acquired customer relationship and technology and patent intangible assets from our acquisitions of eCopy in September 2009 and SpinVox in December 2009. Fiscal 2010 amortization expense also increased over fiscal 2009 due to our acquisition and licensing of certain technology from third-parties during fiscal 2009 and 2010.

 

Based on our balance of amortizable intangible assets as of September 30, 2011, and assuming no impairment or change in useful lives, we expect amortization of intangible assets for fiscal 2012 to be $141.7 million.

 

Acquisition-Related Costs, Net

 

Acquisition-related costs include those costs related to business and other acquisitions, including potential acquisitions. These costs consist of (i) transition and integration costs, including retention payments, transitional

employee costs and earn-out payments treated as compensation expense, as well as the costs of integration-related services provided by third-parties; (ii) professional service fees, including direct third-party costs of the transaction and post-acquisition legal and other professional service fees associated with disputes and regulatory matters related to acquired entities; and (iii) adjustments to acquisition-related items that are required to be marked to fair value each reporting period, such as contingent consideration, and other items related to acquisitions for which the measurement period has ended. Acquisition-related costs were recorded as follows (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The decrease in acquisition-related costs, net for fiscal 2011, as compared to fiscal 2010, was primarily driven by the reduction in transition and integration costs. For fiscal 2010, $8.9 million of transition and integration costs was driven by our acquisitions of eCopy and SpinVox.

 

Fiscal 2010 Compared to Fiscal 2009

 

The increase in acquisition-related costs, net for fiscal year 2010, as compared to fiscal 2009, was largely a result of our adoption of ASC 805, Business Combinations, on October 1, 2009, which requires that transaction costs related to acquisitions be expensed as incurred. We recognized approximately $9.4 million in transaction costs, included within professional service fees above, during fiscal 2010 that would have been included as part of the consideration transferred and capitalized in periods prior to our adoption of ASC 805. This includes $2.2 million that had been capitalized as of September 30, 2009 related to costs incurred in prior periods that was required to be expensed upon our adoption of ASC 805. The remainder of the increase was primarily attributable to an $8.9 million increase in transition and integration costs primarily driven by our acquisitions of eCopy and SpinVox.

Restructuring and Other Charges, Net

 

The following table sets forth the activity relating to the restructuring accruals included in Restructuring and Other Charges, net, in fiscal 2011, 2010 and 2009 (dollars in millions):

 

 

For fiscal 2011, we recorded net restructuring and other charges of $23.0 million, which consisted primarily of an $11.7 million impairment charge related to our Dictaphone trade name resulting from a recent change in our Healthcare marketing strategy under which we plan to consolidate our brands and will no longer be using the Dictaphone trade name in our new product offerings. In addition, we recorded a $9.1 million charge related to the elimination of approximately 200 personnel across multiple functions primarily to eliminate duplicative positions as a result of businesses acquired during the year and a $1.9 million charge related to the elimination or consolidation of excess facilities.

 

For fiscal 2010, we recorded net restructuring and other charges of $18.7 million, which consisted primarily of $9.6 million related to the elimination of approximately 175 personnel across multiple functions within our company, including acquired entities, a $6.8 million write-off of previously capitalized patent defense costs as a result of unsuccessful litigation and $2.1 million of contract termination costs. Excluding the $6.8 million write-off of previously capitalized patent defense costs, restructuring charges increased for fiscal 2010, as compared to fiscal 2009, as a result of the adoption of the business combinations guidance in ASC 805. Under the previous accounting guidance, restructuring costs related to certain post-acquisition activities to integrate acquired companies were generally recorded at the date of acquisition, while the guidance in ASC 805 generally requires that these costs be recorded to the acquiring company’s statement of operations as the activities are undertaken.

 

For fiscal 2009, we recorded restructuring and other charges of $5.4 million, of which $5.3 million related to the elimination of approximately 220 personnel across multiple functions within our company.

Other Income (Expense)

 

Other income (expense) consists of interest income, interest expense, gain (loss) from security price guarantee derivatives, gain (loss) from foreign exchange, and gains (losses) from other non-operating activities. The following table shows other income (expense) in dollars and as a percentage of total revenue (dollars in millions):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

The decrease in interest expense for fiscal 2011, as compared to fiscal 2010, was primarily driven by decreased interest costs as a result of lower rates on our outstanding variable rate borrowings. The increase in other income, net was primarily driven by a $9.3 million increase in gains on our security price guarantee derivatives. This was offset by a decrease in foreign exchange gains of $4.7 million resulting from our implementation of a hedging program in fiscal 2011 to reduce our exposure to changes in foreign currency exchange rates.

 

Fiscal 2010 Compared to Fiscal 2009

 

The change in other income, net for fiscal 2010, as compared to fiscal 2009, was primarily driven by changes in foreign exchange as a result of the U.S. dollar and British pound strengthening against the euro primarily in the first three quarters of fiscal 2010, offset by a one time gain taken in 2009 relating to the foreign currency contracts that were not designated as hedges in fiscal 2009. Interest income and interest expense were lower due to lower prevailing market rates.

 

(Benefit) provision for Income Taxes

 

The following table shows the provision for income taxes and the effective income tax rate (dollars in thousands):

 

 

Fiscal 2011 Compared to Fiscal 2010

 

Our effective income tax rate was (27.4)% and (1,693.3)% for fiscal 2011 and 2010, respectively. The decrease in the tax provision from 2010 to 2011 was primarily related to a one-time tax benefit recorded in connection with the Equitrac acquisition for which a net deferred tax liability was recorded in purchase accounting, resulting in a release of our valuation allowance of $34.7 million and therefore a tax benefit during the year. The decrease in the tax provision was also due to a release of $10.6 million of our valuation allowance associated with the change in characterization of a previously acquired intangible asset from an indefinite life asset to a finite life asset during our fourth quarter of fiscal 2011. These deferred tax benefits were offset by a $21.4 million increase in our current income tax provision primarily driven by higher U.S. taxable income.

Fiscal 2010 Compared to Fiscal 2009

 

Our effective income tax rate was (1,693.3)% and 192.3% for fiscal 2010 and 2009, respectively. The decrease in the rate was due partially to the adoption of ASC 805, which no longer requires the release of the valuation allowance on acquired tax assets to be included as a component of goodwill. Under the new standard, such benefits are included in the statements of operations as a reduction to the provision for income taxes. Also contributing to the decrease was an $8.0 million tax provision recorded during fiscal 2009 upon our election to treat the eScription acquisition as an asset purchase, as well as a $3.2 million tax provision recorded during fiscal 2009 as a result of a Massachusetts state tax law enactment relating to the utilization of net operating losses. The decreases were partially offset by an increase in the fiscal 2010 foreign tax provision resulting from increased foreign profits in certain jurisdictions.

 

SEGMENT ANALYSIS

 

Prior to the fourth quarter of fiscal 2011, the Company operated in one reportable segment as the Chief Operating Decision Maker (“CODM”) regularly reviewed revenue data by market group, while reviewing gross margins, operating margins, and other measures of income or loss on a consolidated basis to manage the business, allocate resources and assess performance.

 

Effective in the fourth quarter of fiscal 2011, our CODM commenced regular reviews of the operating results including measures of profitability of each of our market groups; Healthcare, Mobile and Consumer, Enterprise and Imaging. As a result, we have changed our segment structure and identified our four customer-facing market groups as reportable segments as defined by ASC 280, Segment Reporting, based on the level of financial information now regularly reviewed by the CODM in allocating resources and assessing performance of each market group.

 

The Healthcare segment is primarily engaged in voice and language recognition for healthcare information management offered both by licensing and on-demand services. The Mobile and Consumer segment is primarily engaged in sales of voice and language solutions that are embedded in a device (such as a cell phone, car or tablet computer) or installed on a personal computer. Our Enterprise segment offers voice and language solutions by licensing as well as on-demand solutions hosted by us that are designed to help companies better support, understand and communicate with their customers. The Imaging segment sells document capture and print management solutions that are embedded in copiers and multi-function printers as well as packaged software for document management.

 

Segment revenues include revenue related to acquisitions, primarily from the fiscal 2010 eCopy transaction and the fiscal 2011 purchases of Equitrac and SVOX that would otherwise have been recognized but for the purchase accounting treatment of these transactions. Segment revenues also include revenue that we would have otherwise recognized had we not acquired intellectual property and other assets from the same customer during the same quarter. We include these revenues and the related cost of revenues to allow for more complete comparisons to the financial results of historical operations, forward-looking guidance and the financial results of peer companies and in assessing management performance. Segment profit reflects the direct controllable costs of each segment together with an allocation of sales and corporate marketing expenses, and certain research and development project costs that benefit multiple product offerings.

 

Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit represents income from operations excluding stock-based compensation, amortization of intangible assets, acquisition related costs, net, restructuring and other charges, net, costs associated with intellectual property collaboration agreements, other income (expense), net and certain unallocated corporate expenses. Segment profit includes an adjustment for acquisition-related revenues and cost of revenues which includes revenue from acquisitions that would have otherwise been recognized but for the purchase accounting treatment of these transactions. We believe that these adjustments allow for more complete comparisons to the financial results of the historical operations.

 

 

a) Segment revenues differ from reported revenues due to certain revenue adjustments related to acquisitions that would otherwise have been recognized but for the purchase accounting treatment of the business combinations. Segment revenues also include revenue that the business would have otherwise recognized had we not acquired intellectual property and other assets from the same customer. These revenues are included to allow for more complete comparisons to the financial results of historical operations and in evaluating management performance.

 

(b) Segment profit reflects the direct controllable costs of each segment together with an allocation of sales and corporate marketing expenses, and certain research and development project costs that benefit multiple product offerings. The costs of acquisition related revenue adjustments are included to allow for more complete comparisons of the historical operations.

 

Segment Revenue

 

Fiscal 2011 Compared to Fiscal 2010

 

 

 

Fiscal 2010 Compared to Fiscal 2009

 

 

Segment Profit

 

Fiscal 2011 Compared to Fiscal 2010

 

 

Fiscal 2010 Compared to Fiscal 2009

 

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash and cash equivalents totaled $447.2 million as of September 30, 2011, a decrease of $69.4 million as compared to $516.6 million as of September 30, 2010. Our working capital, which at September 30, 2011 included short-term marketable securities of $31.2 million, was $379.9 million compared to $459.2 million of working capital at September 30, 2010. Working capital at September 30, 2010 excluded $28.3 million of marketable securities that were classified as non-current. Cash and cash equivalents held by our international operations totaled $61.7 million and $40.5 million at September 30, 2011 and 2010, respectively. We expect the cash held overseas will continue to be used for our international operations and therefore do not anticipate repatriating these funds. If we were to repatriate these amounts, we do not believe that the withholding taxes payable as a result would have a material impact on our liquidity. As of September 30, 2011, our total accumulated deficit was $243.1 million. We do not expect our accumulated deficit to impact our future ability to operate the business given our strong cash and operating cash flow positions.

 

On October 6, 2011, we acquired Swype, Inc., a provider of software that allows users to type by sliding a finger or stylus from letter to letter, for approximately $77.5 million in cash, plus $25.0 million in contingent payments, due in eighteen months subject to certain conditions.

 

On October 24, 2011, we sold $690 million of 2.75% Convertible Debentures due November 1, 2031. Total proceeds, net of debt issuance costs of approximately $14.0 million, were $676.0 million. We used $200 million of the proceeds to repurchase 8.5 million shares of our common stock. Interest at 2.75% per year is payable in cash semiannually. We believe our current cash and cash equivalents and marketable securities, together with the proceeds of our recent convertible debt issuance are sufficient to meet our operating needs for at least the next twelve months.

 

Cash provided by operating activities

 

Fiscal 2011 Compared to Fiscal 2010

 

Cash provided by operating activities for fiscal 2011 was $357.4 million, an increase of $61.1 million, or 21%, as compared to cash provided by operating activities of $296.3 million for fiscal 2010. The increase was primarily driven by the following factors:

 

 

Fiscal 2010 Compared to Fiscal 2009

 

Cash provided by operating activities for fiscal 2010 was $296.3 million, an increase of $37.6 million, or 15%, as compared to cash provided by operating activities of $258.7 million for fiscal 2009. The increase was primarily driven by the following factors: