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Nuance Communications 10-K 2006 Documents found in this filing:
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UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 0-27038
NUANCE COMMUNICATIONS,
INC.
Registrant’s telephone number, including area code
(781) 565-5000
SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) 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 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. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
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 $1,514,563,908 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 November 30, 2006, was 170,981,880.
Portions of the Registrant’s definitive Proxy Statement to
be delivered to stockholders in connection with the
Registrant’s 2007 Annual Meeting of Stockholders are
incorporated by reference into Part III of this
Form 10-K.
NUANCE
COMMUNICATIONS, INC.
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This Annual Report on
Form 10-K
contains forward-looking statements within the meaning of the
Federal securities laws that involve risks, uncertainties and
assumptions that, if they never materialize or if they prove
incorrect, could cause our 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 revenue, earnings, cash flows and
liquidity; our strategy relating to speech and imaging
technologies; the potential of future product releases; our
product development plans and investments in research and
development; future acquisitions; international operations and
localized versions of our products; our contractual commitments;
our 2007 revenue 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 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.
Nuance Communications, Inc. is a leading provider of speech and
imaging solutions for businesses and consumers around the world.
Our technologies, applications and services are transforming the
way people create, use and interact with information and make
the experience of our end users a more compelling, convenient
and satisfying one.
The value of our solutions is best realized in markets that are
information and process-intensive, such as healthcare,
telecommunications, financial services, legal services and
government administration. We deliver premier, comprehensive
technologies and services as an independent application or as
part of a larger integrated system. We are an active participant
in rapidly growing markets for speech, including healthcare
dictation and transcription, call center automation, mobile
search and communication and embedded technologies for consumer
products. In imaging, we are positioned to benefit from
increasing demand for PDF and networked imaging solutions.
Every day, millions of users and thousands of businesses
experience Nuance by calling directory assistance, getting
account information over a telephone, dictating patient records,
controlling mobile phones using their voice or reproducing
documents that can be shared and searched. As of
September 30, 2006, we have deployed thousands of speech
applications for some of the world’s most respected
companies, manufacturers and healthcare organizations. Our
imaging devices are used by millions of business professionals
and are included in hundreds of imaging devices and applications.
Today, we offer the world’s largest portfolio of speech and
imaging products backed by the expertise of our professional
services organization and a partner network that can create
solutions for businesses and organizations around the globe. We
market and distribute our products indirectly through a global
network of resellers comprising system integrators, independent
software vendors, value-added resellers, hardware vendors,
telecommunications carriers and distributors; and directly to
businesses and consumers through a dedicated direct sales force
and our
e-commerce
website (www.nuance.com).
Our business is predicated on providing our partners and
customers with a comprehensive portfolio of value-added
solutions, ensuring technological leadership, promoting the
broad adoption of our innovative technology and building global
sales and channel relationships. From our founding until 2001,
we focused exclusively on delivering imaging solutions that
simplified converting and managing information as it moved from
paper formats to electronic systems. In December 2001, we
entered the speech market through the acquisition of the
Speech & Language Technology Business from
Lernout & Hauspie. We believed speech solutions were a
natural complement
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to our imaging solutions as both are developed, marketed and
delivered through similar resources and channels. We continue to
execute against our strategy of being the market leader in
speech solutions through the organic growth of our business as
well as through strategic acquisitions. We have successfully
completed 15 acquisitions since 2000 and we expect to
continue to make acquisitions of other companies, businesses and
technologies to complement our internal investments.
Acquisitions completed in recent fiscal years include the
following significant transactions:
To partially finance our acquisition of Dictaphone, on
March 31, 2006 we entered into a new senior secured credit
facility which consists of a $355.0 million
7-year term
loan and a $75.0 million six-year revolving credit line.
Nuance was 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 2004, we changed our fiscal year end to
September 30, resulting in a nine-month fiscal year for
2004. In October 2005, we changed our name to Nuance
Communications, Inc., to reflect our core mission of being the
world’s most comprehensive and innovative provider of
speech solutions, and in November 2005 we changed our ticker
symbol to NUAN. Except as otherwise indicated, all references in
this report to “Nuance”, “the Company”,
“we”, “our” or “ScanSoft,” refer
to Nuance Communications, Inc.
In the past decade, information has become an increasingly
important resource for businesses and enterprises. The ability
to access, exchange and manage information with speed and
sophistication through various means — information
systems, dictation processes, call centers, documents, mobile
devices — is often an important characteristic of the
most successful organizations worldwide. Many organizations
define their strategy and assess their ability to compete and
manage their customer relationships based on the quality,
diversity and availability of their information products,
services and resources. The format of vital information is wide
and varied, ranging from the spoken word in multiple languages
to customer database systems to paper, electronic files and
Internet content.
Confronted by exponentially increasing information through more
and more channels, consumers, business personnel and healthcare
professionals employ a variety of resources for retrieving
information, transcribing patient information, conducting
transactions and performing their jobs. The Internet,
telecommunications systems, wireless and mobile networks and
related corporate infrastructure have emerged as powerful global
communications networks and channels for conducting business.
These electronic systems have fundamentally changed the way
organizations and consumers obtain information, communicate,
purchase goods and conduct business. Today, businesses and
manufacturers around the world share a common motivation to
enhance the service they provide to their customers and
differentiate their offerings while improving operating
efficiency. Customer satisfaction, employee productivity and
company operating results can often be linked to an
organization’s ability to manage, utilize and communicate
information effectively.
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Nuance
Solutions
We create technologies, applications and solutions that
transform the way people access, share, manage and use
information, both in business and in daily life. We help
enterprises, professionals and consumers increase productivity,
reduce costs and save time by developing and commercializing new
technologies that make the user experience more compelling and
productive. Our speech offerings utilize the human voice, and we
are advancing towards our vision of the future where natural
conversations will be the preferred interface for these
interactions and will make the user experience more compelling.
Our imaging solutions build on decades of experience and
technology development to deliver businesses, manufacturers and
consumers a broad set of PDF and document offerings.
We provide a broad set of speech and imaging offerings to our
customers that increase their end users’ productivity,
reduce costs and save time in the following areas:
Organizations turn to our speech solutions as a means to improve
the quality of their customer care while reducing the associated
costs and ensuring a positive customer experience. Our speech
solutions allow users to direct their own calls, obtain
information and conduct transactions by simply speaking
naturally over any telephone.
Our speech solutions are used within a wide range of
applications across many customer-service intensive sectors,
including financial services, telecommunications, healthcare,
utilities, government, travel and entertainment. For example,
our software is integrated into applications that provide flight
information, personal banking, equipment repair and claims
processing. We provide an extensive portfolio of speech
technologies and applications that offer superior accuracy,
support up to 49 languages and dialects for our speech
recognition and offer 26 languages in our natural sounding
synthesized speech. Our solutions adhere to global industry
standards and we provide speech technologies and services in
more languages than any other vendor worldwide.
These speech solutions are licensed to enterprises, such as
those in the Fortune 1000, and telecommunications carriers.
Although in certain cases we sell directly to our customer, the
majority of our solutions are fulfilled through our channel
networks comprised of telecommunications equipment companies,
systems integrators and technology providers, such as Avaya,
Cisco, Genesys, Intervoice and Nortel, that integrate our
solutions into their proprietary hardware and software platforms.
We complement our technologies and products with a global
professional services organization that supports customers and
partners with business and systems consulting project
management, user interface design and application development
assistance. We service our customers from our corporate
headquarters in Burlington, Massachusetts and through other
principal offices located in the United States, Canada, Belgium,
Israel and Japan.
The healthcare industry is under pressure to streamline
operations and reduce costs while at the same time find new ways
to improve patient care. In recent years, the healthcare
industry — comprising hospitals, clinics, medical
groups, physicians’ offices, insurance providers and
service organizations — has increasingly turned to
speech solutions to automate manual processes, especially with
respect to dictation and transcription.
Today, clinical documentation is based largely on the manual
transcription of recorded physician dictation, representing a
significant industry worldwide. This presents an opportunity for
us to apply speech technologies to automate manual processes,
reduce costs, speed access to accurate data, and significantly
improve patient care.
We are a leading supplier of speech recognition solutions to the
healthcare industry through desktop and integrated OEM dictation
products, and recently through complete transcription processing
and workflow solutions. In March 2006, we acquired Dictaphone
Corporation to expand our product portfolio, market reach and
revenue streams within the large and rapidly growing healthcare
vertical.
Today, more than 3,000 hospitals, clinics, and group practices,
and over 400,000 physicians, use our Dictaphone healthcare
solutions to manage the dictation and transcription of patient
records. Our voice platform helps reduce the high cost of
medical reporting, manage both a traditional transcription
workflow and the use of in-
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house speech recognition and reduce the reliance on manual
transcription. Our enterprise-level speech recognition includes
phone-based dictation, transcriptionist editing tools and
physician self-completion control.
Our desktop dictation applications increase productivity by
using speech to create documents, streamline repetitive and
complex tasks, input data, complete forms and automate manual
transcription processes. The Dragon NaturallySpeaking family of
products delivers enhanced productivity for professionals and
consumers who need to create documents and transcripts.
Professionals and consumers also look to our dictation solutions
as a way to maximize the productivity of their existing workers,
including those with disabilities, and to comply with government
requirements relating to workplace safety and accessibility.
Our Dragon NaturallySpeaking solutions allow users to
automatically convert speech into text at up to
160 words-per-minute.
Our software supports a vocabulary of more than 300,000 words
that can be expanded by users to include specialized words and
phrases, is designed to adapt to individual voice patterns and
accents and is able to achieve accuracy rates of up to 99%.
We offer a range of desktop and server solutions, each with
features that match a specific customer target. Our dictation
software is currently available in eight languages. We utilize a
combination of our global reseller network and direct sales to
distribute our speech recognition and dictation products.
Voice capabilities are becoming ubiquitous in consumer and
mobile devices, from cell phones and PDAs to automobiles and
navigation systems. Our embedded speech solutions add voice
control capabilities to these devices, allowing people to use
spoken words or commands for dialing a mobile phone by saying a
name, entering destination information into an automotive
navigation system, dictating a text message or having emails and
screen information read aloud.
Our embedded speech solutions identify specific words and
phrases at any moment in time and convert these spoken words
into instructions that control specific functions within
applications. Our solutions support dynamic vocabularies and
have sophisticated noise management capabilities that improve
accuracy, even in noisy environments. Our products scale to meet
the size and accuracy requirements for automotive and navigation
systems and offer rapid application development tools, extensive
compatibility with hardware and operating systems and support of
multiple languages.
Our embedded speech solutions are used by automobile, cell
phone, entertainment and aftermarket system manufacturers and
their suppliers including Alpine, Bosch-Blaupunkt, Delphi,
General Motors, LG, Microsoft, Motorola, Nokia, Pioneer,
Samsung, Sony and Visteon. These technologies are included as
part of a larger system, application or solution that is
designed, manufactured and sold by our customers. These
customers include handset and other device manufacturers and
tier-one suppliers; companies whose size and importance qualify
them to be direct suppliers to the major automotive
manufacturers as well as in-dash radio, navigation system and
other electronic device manufacturers.
The mobile device and wireless phone market is one of the
fastest growing technology markets in the world and the
opportunity to provide content, advertising, and services
creates a significant opportunity. While many phones and devices
today have Web and data capabilities, advanced mobile phone
functionality and much of the available mobile content remains
virtually invisible to users because it is too deeply hidden in
confusing menu hierarchies. We believe speech technology
provides a means to overcome these challenges and create growth
for mobile services.
Our mobile speech solutions, comprising elements from many of
our dictation, network and embedded speech solutions, offer an
innovative approach to accessing search and communications
services on mobile devices. We offer user interaction with
mobile search and communications applications that enable
consumers to significantly
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increase the utility of their mobile devices, while enabling
handset vendors and service providers to tap into significant
new sources of revenue.
Our search and communication solutions allow consumers to use
their voices to browse and download mobile content including
ringtones, music, videos, wallpapers, and games; search local
information databases for business listings, yellow pages,
restaurant guides and movie schedules by naturally speaking
their requests; dictate text messages to mobile instant
messaging and mobile email dictation significantly faster than
with the keypad; and allow wireless subscribers to access their
personal or public address books, calendar and a range of
information services using simple speech commands.
Our PDF and document imaging solutions help businesses and
consumers by automating a range of document
processes — increasing productivity, saving time and
reducing costs. With products for enterprises,
small-to-medium-sized
businesses and home offices, our ScanSoft Imaging Solutions
offer cost-effective PDF applications for business users;
convert paper and PDF into documents that can be easily edited;
and simplify scanning and document management using
multifunction scanners and networked digital copiers.
Our OmniPage product family uses optical character recognition
technology to deliver highly accurate document and PDF
conversion, replacing the need to manually re-create documents.
Our OmniPage applications are used by individuals and in
professional office settings. We utilize a combination of our
global reseller network and direct sales to distribute our
document conversion and PDF products. We license our software to
companies such as Brother, Canon, Dell, HP and Xerox, which
bundle our solutions with multifunction devices, digital
copiers, printers and scanners. We also license software
development toolkits to independent software vendors who use our
technology for production capture or desktop applications,
including vendors such as Autodesk, Canon,
EMC/Captiva,
Filenet, Kofax, Microsoft, Sharp and Verity.
Our PaperPort product family converts paper into digital
documents that can be easily archived, retrieved and shared. Our
software can be used in conjunction with network scanning
devices to preserve an image of a document exactly as it appears
on paper. Our software automatically indexes the scanned image
so that it can be stored together with other digital documents
on a desktop, over a network or within an enterprise content
management system. We utilize a combination of our global
reseller network and direct sales to distribute our digital
paper management products. We also license our software to
companies such as Brother, Hewlett-Packard, and Xerox, who
bundle our solutions with multifunction devices, digital
copiers, printers and scanners.
Our PDF Converter product family comprises affordable solutions
used to create PDF files and turn existing PDF files into
fully-formatted Microsoft Word, Microsoft Excel and Corel
WordPerfect documents that can be edited. Our PDF solutions are
used by business professionals and consumers and have proven to
be a cost-effective alternative to those offered by Adobe
Systems. PDF Converter Professional, our flagship PDF
application, allows users to view, manipulate and edit PDF
documents as well as create and complete PDF forms. PDF Create!
is an affordable solution to enable the creation of PDF from all
PC applications, including support for PDF security, font
embedding and other advanced features.
We market and distribute our products through a variety of
means, including indirectly through a global network of
resellers, comprising system integrators, independent software
vendors, value-added resellers, hardware vendors,
telecommunications carriers and distributors and directly
through our dedicated direct sales force and through our
e-commerce
website (www.nuance.com).
We have established relationships with more than 2,000 channel
partners, including leading system vendors, independent software
vendors, value-added resellers and distributors, through whom we
market and distribute our products and solutions. In speech,
companies such as Avaya, Bosch-Blaupunkt, Cisco, Delphi,
Genesys, LG, Microsoft, Nokia, Nortel, Samsung and Visteon embed
our technologies into telecommunications systems and automotive,
PC, handset, healthcare or multimedia applications. In Imaging,
companies such as Brother, Dell, Hewlett-Packard, Visioneer and
Xerox include our technology in digital copiers, printers and
scanners, as well as
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multifunction devices that combine these capabilities and
companies such as Corel, Canon, Captiva, Kofax, Sharp and Verity
embed our imaging technology into their commercial software
applications.
We license our applications to enterprises, professionals and
consumers through distribution and fulfillment partners,
including 1450, Ingram Micro, Tech Data and Digital River. These
distribution and fulfillment partners provide our products to
computer superstores, consumer electronic stores, eCommerce Web
sites, mail order houses and office superstores, such as
Amazon.com, Best Buy, CDW, MicroWarehouse, Circuit City,
CompUSA, Fry’s Electronics, Office Depot, PC Connection and
Staples.
As of September 30, 2006, we had 448 full-time
employees in sales and marketing, with 298 in the
United States and 150 internationally.
In recent years, we have developed and acquired extensive
technology assets, intellectual property and industry expertise
in speech and imaging which provide us with a competitive
advantage in markets where we compete. Our technologies are
based on complex mathematical formulas 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 our technologies to maintain our
market-leading position and to develop new applications. Our
technologies are covered by more than 550 patents or patent
applications, expiring on various dates between 2006 and 2023.
Our intellectual property, whether purchased and included as an
asset on our balance sheet, or developed internally and thus not
generally included as an asset on our balance sheet, is critical
to our success and competitive position and, ultimately, to our
market value. We rely on a combination of patents, copyrights,
trademarks, services marks, trade secrets, confidentiality
provisions and licensing arrangements to establish and protect
our intellectual property and proprietary rights.
As of September 30, 2006, we had 417 full-time
employees in research and development. Our research and
development expenses for the twelve months ended
September 30, 2006 and 2005, and the nine months ending
September 30, 2004 were $59.4 million,
$39.2 million and $26.4 million, respectively.
Our international headquarters are located in Belgium and we
have additional principal offices in a number of international
locations including: Canada, Germany, Hungary, Israel, Japan and
the United Kingdom. The responsibilities of our international
operations include research and development, 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 2006, 2005
and 2004, 74%, 69% and 70% of revenue was generated in the
United States and 26%, 31% and 30% of revenue was generated by
our international operations, respectively.
For a discussion of risks attendant to our international
operations, see Risk Factors — “A significant
portion of our revenue is derived from sales in Europe and Asia.
Our results could be harmed by economic, political, regulatory
and other risks associated with these and other international
regions.”
We focus on providing competitive and value-added solutions for
our customers and partners through a broad set of technologies,
service offerings and channel capabilities. To continue to
provide industry leading solutions, through acquisitions and
organic growth, we intend to:
Participate Broadly In Speech. We intend to
leverage our comprehensive technologies and leadership in speech
to expand our opportunities in the call center, automotive,
healthcare, telecommunications and mobile markets. We also
intend to pursue emerging opportunities to use our speech
technologies within consumer devices, games and other embedded
applications. To expand our position in speech, we intend to
introduce new versions of
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our products and applications complete new license agreements
with customers and partners that will resell our technologies;
and continue to make strategic acquisitions that we believe
complement our existing capabilities in the telecommunications,
automotive and electronics markets.
Pursue Opportunities for Dictation and Transcription in
Healthcare. We intend to increase our investments
and efforts in providing dictation solutions to the healthcare
market, where we believe there is a large and attractive
opportunity to automate transcription processes and information
workflow. We have formed a healthcare-specific sales
organization to aggressively pursue sales into healthcare
provider organizations; expanded our reseller and system
integrator channels within healthcare; and entered into OEM
license agreements with leading healthcare IT hardware and
software vendors.
Pursue Strategic Acquisitions. We have
selectively pursued strategic acquisitions to expand our
technology, channel and service resources and to complement our
organic growth. We expect to continue to make acquisitions of
other companies, businesses and technologies to complement our
existing capabilities and our internal investments in these
areas and have a team that focuses on evaluating market needs
and potential acquisitions to fulfill them. We have a
disciplined methodology for integrating acquired companies and
businesses after the transaction is complete.
Expand Worldwide Channels. We intend to expand
our global channel network and build upon our existing
distribution channels, especially in Europe, Asia and Latin
America. Along these lines, we have added sales employees in
different geographic regions and launched programs and events to
help recruit new partners for our channel network.
Expand PDF and Imaging Solutions. We intend to
enhance the value and functionality of our PDF and imaging
solutions to enable enterprises to address the proliferation of
PDF, the expanded use of content management systems and the
widespread adoption of networked multifunction and digital
scanning devices. We intend to continue to introduce new and
improved versions of our products to take advantage of
developing market opportunities. We also plan to enhance our
software development toolkits so our technologies can be
integrated with more third-party and OEM solutions.
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:
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Within speech, we compete with AT&T, Fonix, IBM, Loquendo,
Microsoft, Philips, Telisma and Voice Signal. Within healthcare
dictation and transcription, we compete with Philips Medical,
Spheris and other smaller providers. Within imaging, we compete
directly with ABBYY, Adobe, eCopy, and I.R.I.S. In speech, some
of our partners such as Avaya, Cisco, Edify, Genesys and Nortel
develop and market products that can be considered substitutes
for our solutions. In addition, a number of smaller companies in
both speech and imaging produce technologies or products that
are competitive with our solutions in some markets. 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 in our markets,
such as Adobe, IBM and Microsoft, 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.
See “Risk Factors — The markets in which we
operate are highly competitive and rapidly changing, and we may
be unable to compete successfully.”
As of September 30, 2006, Nuance employed
1,681 full-time employees worldwide in 16 countries,
including 448 in sales and marketing, 417 in research and
development, 329 in professional service consulting, 211 in
customer service and support and 276 in general and
administration, including information services personnel. 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.
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 (“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. 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.
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Risks
Related to Our Business
Our revenue and operating results have fluctuated in the past
and we expect our revenue and operating results to continue to
fluctuate in the future. Given this fluctuation, we believe that
quarter to quarter comparisons of our 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 our 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.
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 acquisition of Dictaphone
Corporation. We may continue to issue equity securities for
future acquisitions that would dilute our existing stockholders,
perhaps significantly depending on the terms of the acquisition.
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.
Furthermore, our prior acquisitions required substantial
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integration and management efforts. Our recently completed
acquisition of Dictaphone Corporation will likely pose similar
challenges. Acquisitions of this nature involve a number of
risks, including:
As a result of these and other risks, we may not realize
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.
Under accounting principles generally accepted in the United
States of America, we have accounted for our acquisitions using
the purchase method of accounting. Under purchase accounting, we
record the market value of our common stock or other form of
consideration issued in connection with the acquisition and the
amount of direct transaction costs 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. Intangible
assets generally will be amortized over a five to ten year
period. Goodwill and certain intangible assets with indefinite
lives, are not subject to amortization but is subject to at
least an annual impairment analysis, which may result in an
impairment charge if the carrying value exceeds its implied fair
value. As of September 30, 2006, we had identified
intangible assets amounting to approximately $220.0 million
and goodwill of approximately $699.3 million.
We have a significant amount of debt. On March 31, 2006, we
entered into a credit facility which consists of a
$355.0 million
7-year term
loan and a $75.0 million six-year revolving credit line. As
of September 30, 2006, $353.2 million remained
outstanding under the term loan and there were no outstanding
borrowings under the revolving credit line. Our high level of
debt could have important consequences, for example it could:
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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 cash flow. While we have entered into an interest rate swap
agreement limiting our exposure for a portion of our debt, such
agreement does not offer complete protection from this risk.
We reported net losses of approximately $22.9 million,
$5.4 million and $9.4 million for fiscal years 2006,
2005 and 2004, respectively. We had an accumulated deficit of
approximately $190.1 million at September 30, 2006. If
we are unable to achieve and 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
achieve or maintain profitability in the future. If we do not
achieve profitability, we may be required to raise additional
capital to maintain or grow our operations. The terms of any
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.
We are dependent on certain suppliers, including limited and
sole source suppliers, to provide key components used in our
products. We have experienced, and may continue to experience,
delays in component deliveries, which in turn could cause delays
in product shipments and require the redesign of certain
products. In addition, if we are unable to procure necessary
components under favorable purchase terms, including at
favorable prices and with the order lead-times needed for the
efficient and profitable operation of our business, our results
of operations could suffer.
We have invested and expect to continue to invest heavily in the
acquisition, development and marketing of speech technologies.
The market for speech technologies is relatively new and rapidly
evolving. Our ability to increase revenue in the future depends
in large measure on acceptance of speech technologies in general
and our products in particular. The continued development of the
market for our current and future speech solutions will also
depend on the following factors:
Sales of our speech products would be harmed if the market for
speech software does not continue to develop or develops more
slowly than we expect, and, consequently, our business could be
harmed and we may not recover the costs associated with our
investment in our speech technologies.
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 imaging, we compete directly with
ABBYY, Adobe, I.R.I.S. and NewSoft. Within speech, we compete
with AT&T, Fonix, IBM, Microsoft and Philips. Within
healthcare dictation and transcription, we compete with Philips
Medical, Spheris and other smaller providers. In speech, some of
our partners such as Avaya, Cisco, Edify, Genesys and Nortel
develop and market products that can be considered substitutes
for our solutions. In addition, a number of smaller companies
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in both speech 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, IBM and Microsoft, 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 IBM and Microsoft, 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 advancements. 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.
Our management’s assessment of the effectiveness of our
internal control over financial reporting, as of
September 30, 2005, identified a material weakness in our
internal controls related to tax accounting, primarily as a
result of a lack of necessary corporate accounting resources and
ineffective execution of certain controls designed to prevent or
detect actual or potential misstatements in the tax accounts.
While we have taken remediation measures to correct this
material weakness, which measures are more fully described in
Item 9A of this Annual Report on
Form 10-K,
we cannot assure you that we will not have material weaknesses
in our internal controls in the future. 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 results in an accurate and timely manner.
Since we license our products worldwide, our business is subject
to risks associated with doing business internationally. We
anticipate that revenue from international operations will
continue to increase in their total U.S. dollar value.
Reported international revenue, classified by the major
geographic areas in which our customers are located, for fiscal
2006, 2005 and 2004 represented approximately
$100.2 million, $71.5 million and $39.4 million,
respectively. 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. A
significant portion of the development and manufacturing of our
speech products are completed in Belgium, and a significant
portion of our imaging research and development is conducted in
Hungary. In connection with the Philips acquisition, we added an
additional research and development location in Aachen, Germany,
and in connection with the acquisitions of Locus Dialog and the
former Nuance Communications, In., which we refer to as Former
Nuance, we added additional research and development centers in
Montreal, Canada. Our acquisitions of ART and Phonetic added
research and development and professional services operations in
Tel Aviv, Israel. Accordingly, our future results could be
harmed by a variety of factors associated with international
sales and operations, including:
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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 or declining economic conditions in these countries. In
certain circumstances, we have entered into forward exchange
contracts to hedge against foreign currency fluctuations on
intercompany balances with our foreign subsidiaries. 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. Hedges are designated and documented at the
inception of the hedge and are evaluated for effectiveness
monthly. Forward exchange contracts hedging firm commitments
qualify for hedge accounting when they are designated as a hedge
of the foreign currency exposure and they are effective in
minimizing such exposure. With our increased international
presence in a number of geographic locations and with
international revenue projected to increase in fiscal 2007, we
are exposed to changes in foreign currencies including the Euro,
British Pound, Canadian Dollar, Japanese Yen, Israeli New Shekel
and the Hungarian Forint. Changes in the value of the Euro or
other foreign currencies relative to the value of the
U.S. dollar could adversely affect future revenue and
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 benefit 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 identifiable intangible
assets whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors which 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. As of September 30, 2006, we had
identified intangible assets amounting to approximately
$220.0 million and goodwill of approximately
$699.3 million.
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If any of our key employees were to leave us, 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 us in the past. We cannot assure you that one or
more key employees will not leave us in the future. We intend to
continue to hire additional highly qualified personnel,
including software engineers and operational personnel, but we
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.
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 to us.
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 which
could have a material adverse affect on our business, results of
operations and financial condition.
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 ours
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.
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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.
On November 9, 2006, VoiceSignal Technologies, Inc. filed
an action against us and eleven of our resellers in the United
States District Court for the Eastern District of Texas claiming
patent infringement. Damages were sought in an unspecified
amount. In the lawsuit, VoiceSignal alleges that we are
infringing United States Patent No. 5,855,000 which is
related to improving correction in a dictation application based
on a two input analysis. We believe these claims have no merit
and intend to defend the actions vigorously.
On May 31, 2006 GTX Corporation (“GTX”), filed an
action against us in the United States District Court for the
Eastern District of Texas claiming patent infringement. Damages
were sought in an unspecified amount. In the lawsuit, GTX
alleged that we are infringing United States Patent
No. 7,016,536 entitled “Method and Apparatus for
Automatic Cleaning and Enhancing of Scanned Documents.” We
believe these claims have no merit and intend to defend the
action vigorously.
On November 27, 2002, AllVoice Computing plc
(“AllVoice”) filed an action against us in the United
States District Court for the Southern District of Texas
claiming patent infringement. In the lawsuit, AllVoice alleges
that we are infringing United States Patent No. 5,799,273
entitled “Automated Proofreading Using Interface Linking
Recognized Words to their Audio Data While Text is Being
Changed” (the “’273 Patent”). The ’273
Patent generally discloses techniques for manipulating audio
data associated with text generated by a speech recognition
engine. Although we have several products in the speech
recognition technology field, we believe that our products do
not infringe the ’273 Patent because, in addition to other
defenses, they do not use the claimed techniques. Damages are
sought in an unspecified amount. We filed an Answer on
December 23, 2002. The United States District Court for the
Southern District of Texas entered summary judgment against
AllVoice and dismissed all claims against Nuance on
February 21, 2006. AllVoice filed a notice of appeal from
this judgment on April 26, 2006.
We believe that the final outcome of the current litigation
matters described above will not have a significant adverse
effect on our financial position and results of operations.
However, even if our defense is successful, the litigation could
require significant management time and could be costly. Should
we not prevail in these litigation matters, we may be unable to
sell and/or
license certain of our technologies we consider to be
proprietary, and our operating results, financial position and
cash flows could be adversely impacted.
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.
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On March 19, 2004, Warburg Pincus, a global private equity
firm agreed to purchase all outstanding shares of our stock held
by Xerox Corporation for approximately $80 million.
Additionally, on May 9, 2005 and September 15, 2005 we
sold shares of common stock, and warrants to purchase common
stock to Warburg Pincus for aggregate gross proceeds of
approximately $75.1 million. As of September 30, 2006,
Warburg Pincus beneficially owned approximately 23.4% of our
outstanding common stock, including warrants exercisable for up
to 7,066,538 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. Franklin Resources, Inc. is our second largest
stockholder, owning approximately 5.3% of our common stock as of
September 30, 2006. Because of their large holdings of our
capital stock relative to other stockholders, each of these two
stockholders acting individually, or together, have a strong
influence over matters requiring approval by our stockholders.
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. 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.
Changing laws, regulations and standards relating to corporate
governance and public disclosure, including the Sarbanes-Oxley
Act of 2002, new regulations promulgated by the Securities and
Exchange Commission and the rules of the NASDAQ Global Select
Market, 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.
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:
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None.
Our corporate headquarters and administrative, sales, marketing,
research and development and support functions occupy
approximately 105,000 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, 2006:
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, 2006, 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.
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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.
On November 9, 2006, VoiceSignal Technologies, Inc. filed
an action against us and eleven of our resellers in the United
States District Court for the Eastern District of Texas claiming
patent infringement. VoiceSignal is seeking damages and
injunctive relief. In the lawsuit, VoiceSignal alleges that we
are infringing United States Patent No. 5,855,000 which is
related to improving correction in a dictation application based
on a two input analysis. We believe the claims have no merit and
intend to defend the action vigorously.
On August 22, 2006, z4 Technologies, Inc. filed an action
against us and five other defendants, including Symantec, Adobe,
Quark, ABBYY and Mathsoft, in the United States District Court
for the Eastern District of Texas claiming patent infringement.
Damages were sought in an unspecified amount. In the lawsuit, z4
Technologies alleged that we are infringing United States Patent
Nos. 6,044,471 and 6,785,825 which are directed to a method and
apparatus for reducing unauthorized software use. On
December 4, 2006 we entered into a settlement agreement
with z4 Technologies regarding this action.
On May 31, 2006 GTX Corporation, or GTX, filed an action
against us in the United States District Court for the Eastern
District of Texas claiming patent infringement. Damages were
sought in an unspecified amount. In the lawsuit, GTX alleged
that we are infringing United States Patent No. 7,016,536
entitled “Method and Apparatus for Automatic Cleaning and
Enhancing of Scanned Documents.” We believe the claims have
no merit and intend to defend the action vigorously.
On November 27, 2002, AllVoice Computing plc, or AllVoice,
filed an action against us in the United States District Court
for the Southern District of Texas claiming patent infringement.
In the lawsuit, AllVoice alleges that the Company is infringing
United States Patent No. 5,799,273 entitled “Automated
Proofreading Using Interface Linking Recognized Words to Their
Audio Data While Text Is Being Changed,” or the 273 Patent.
The 273 Patent generally discloses techniques for manipulating
audio data associated with text generated by a speech
recognition engine. Although we have several products in the
speech recognition technology field, we believe that our
products do not infringe the 273 Patent because, in addition to
other defenses, they do not use the claimed techniques. Damages
are sought in an unspecified amount. We filed an Answer on
December 23, 2002. On January 4, 2005, the case was
transferred to a new judge of the United States District Court
for the Southern District of Texas for administrative reasons.
The United States District Court for the Southern District of
Texas entered summary judgment against AllVoice and dismissed
all claims against Nuance on February 21, 2006. AllVoice
filed a notice of appeal from this judgment on April 26,
2006.
In August 2001, the first of a number of complaints was filed in
the United States District Court for the Southern District of
New York, on behalf of a purported class of persons who
purchased Former Nuance stock between April 12, 2000 and
December 6, 2000. Those complaints have been consolidated
into one action. The complaint generally alleges that various
investment bank underwriters engaged in improper and undisclosed
activities related to the allocation of shares in Former
Nuance’s initial public offering of securities. The
complaint makes claims for violation of several provisions of
the federal securities laws against those underwriters, and also
against Former Nuance and some of the Former Nuance’s
directors and officers. Similar lawsuits, concerning more than
250 other companies’ initial public offerings, were filed
in 2001. In February 2003, the Court denied a motion to dismiss
with respect to the claims against Former Nuance. In the third
quarter of 2003, a proposed settlement in principle was reached
among the plaintiffs, issuer defendants (including Former
Nuance) and the issuers’ insurance carriers. The settlement
calls for the dismissal and release of claims against the issuer
defendants, including Former Nuance, in exchange for a
contingent payment to be paid, if necessary, by the issuer
defendants’ insurance carriers and an assignment of certain
claims. The timing of the conclusion of the settlement remains
unclear, and the settlement is subject to a number of
conditions, including approval of the Court. The settlement is
not expected to have any material impact upon Former Nuance or
us, as payments, if any, are expected to be made by insurance
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carriers, rather than by Former Nuance. In July 2004, the
underwriters filed a motion opposing approval by the court of
the settlement among the plaintiffs, issuers and insurers. In
March 2005, the court granted preliminary approval of the
settlement, subject to the parties agreeing to modify the term
of the settlement which limits each underwriter from seeking
contribution against its issuer for damages it may be forced to
pay in the action. On April 24, 2006, the court held a
fairness hearing in connection with the motion for final
approval of the settlement. The court has yet to issue a ruling
on the motion for final approval. On December 5, 2006, the
Court of Appeals for the Second Circuit reversed the
Court’s order certifying a class in several “test
cases” that had been selected by the underwriter defendants
and plaintiffs in the coordinated proceeding. The settlement
remains subject to a number of conditions, including final court
approval. In the event the settlement is not concluded, we
intend to defend the litigation vigorously. We believe we have
meritorious defenses to the claims against Former Nuance.
We believe that the final outcome of the current litigation
matters described above will not have a significant adverse
effect on our financial position or results of operations.
However, even if our defense is successful, the litigation could
require significant management time and will be costly. Should
we not prevail in these litigation matters, our operating
results, financial position and cash flows could be adversely
impacted.
No matters were submitted to a vote of security holders in the
fourth quarter of the fiscal year covered by this Annual Report
on
Form 10-K.
Our common stock is traded on the NASDAQ Global Select Market
under the symbol “NUAN”. The table below shows the
high and low sale prices of our common stock for each quarter of
the fiscal years ended September 30, 2006 and 2005,
respectively, on the NASDAQ Global Select Market.
As of November 30, 2006, there were 923 stockholders of
record of our common stock.
We have never declared or paid any cash dividends on our capital
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.
The terms of our credit facility place restrictions on our
ability to pay dividends except for stock dividends (see
Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results
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of Operations — Liquidity and Capital Resources”
and Note 10 “Debt” in the Notes to Consolidated
Financial Statements).
Issuer
Purchases of Equity Securities
We have not announced any currently effective authorization to
repurchase shares of our common stock. However, upon vesting of
restricted stock awards, employees are permitted to return to us
a portion of the newly vested shares to satisfy the tax
withholding obligations that arise in connection with such
vesting. The following table summarizes repurchases of our
common stock during the fourth quarter of fiscal 2006, which
represent shares returned to satisfy tax withholding obligations:
On October 23, 2004, our Board of Directors approved a
change in the Company’s fiscal year end from
December 31 to September 30, effective beginning
September 30, 2004. All references in this Form
10-K to the
fiscal 2004 refer to the nine month period ended
September 30, 2004. References to fiscal 2005 and 2006,
refer to the twelve month periods ended September 30.
References to fiscal 2003 and prior years, refer to the twelve
month periods ended December 31.
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.
The interim statement of operations for the nine months ended
September 30, 2003 is unaudited and, in the opinion of
management, reflects all adjustments, consisting of normal
recurring adjustments,
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necessary for a fair statement of results of operations for the
nine months ended September 30, 2003. (Amounts in
thousands, except per share dollars and percentages).
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Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The following Management’s Discussion and Analysis, or
MD&A, is intended to help the reader understand the results
of operations and financial condition of our business. MD&A
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.
This annual report contains 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.
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We are a leading provider of speech and imaging solutions for
businesses and consumers around the world. Our technologies,
applications and services are transforming the way people
create, use and interact with information and make the
experience of our end users a more compelling, convenient and
satisfying one.
Our speech technologies enable voice-activated services over a
telephone, transform speech into written word, and permit the
control of devices and applications by simply speaking. With the
acquisition of Dictaphone, we expanded our speech technologies
in the automatic conversion of voice reports into electronic
patient reports for a wide range of users in the transcription
and healthcare industry. We expect our acquisition of Dictaphone
to significantly expand our reach into the healthcare industry.
Our imaging solutions offer cost-effective PDF applications for
business users, convert paper and PDF into documents that can be
easily edited, and simplify scanning and document management
using multifunction scanners and networked digital copiers.
Our software can be delivered as part of a larger integrated
system, such as systems for customer service call centers, or as
an independent application, such as dictation, medical
transcription, document or PDF conversion, navigation systems in
automobiles or digital copiers on a network. In select
situations we sell or license intellectual property in
conjunction with or in place of embedding our intellectual
property in software. Our products and technologies deliver a
measurable return on investment to our customers and our goal is
to help our customers optimize productivity and reduce costs.
We market and distribute our products indirectly through a
global network of resellers comprising system integrators,
independent software vendors, value-added resellers, hardware
vendors, telecommunications carriers and distributors; and
directly to businesses and consumers through a dedicated direct
sales force and our
e-commerce
website (www.nuance.com).
Nuance was 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 2004, we changed our fiscal year end to
September 30, resulting in a nine-month fiscal year for
2004. In October 2005, we changed our name to Nuance
Communications, Inc., to reflect our core mission of being the
world’s most comprehensive and innovative provider of
speech solutions, and in November 2005 we changed our ticker
symbol to NUAN.
Our business is predicated on providing our partners and
customers with a comprehensive portfolio of
value-added
solutions, ensuring technological leadership, promoting the
broad adoption of our innovative technology and building global
sales and channel relationships. We continue to execute our
strategy of maintaining leadership in speech and imaging through
sustained growth in our ongoing operations as well as through
strategic acquisitions that complement our existing capabilities.
Our focus on providing competitive and value-added solutions for
our customers and partners requires a broad set of technologies,
service offerings and channel capabilities. We have successfully
completed and integrated 15 acquisitions since 2000 and we
expect to continue to make acquisitions of other companies,
businesses and technologies to complement our internal
investments. We have a team that focuses on evaluating market
needs and potential acquisitions to fulfill them. In addition,
we have a disciplined methodology for integrating acquired
companies and businesses after the transaction is complete. In
recent fiscal years, we completed a number of acquisitions,
including the following significant transactions:
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The following table presents, as a percentage of total revenue,
certain selected financial data for the twelve months ended
September 30, 2006 and 2005, and the nine months ended
September 30, 2004.
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The following table shows total revenue by geographic location,
based on the location of our customers, in absolute dollars and
percentage change (in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Total revenue for the fiscal year ended September 30, 2006
increased by $156.1 million as compared to the fiscal year
ended September 30, 2005. The increase was primarily due to
$112.4 million of revenue related to our acquisitions of
Former Nuance and Dictaphone. Organic total revenue increased
$43.7 million, or 19%, in fiscal 2006. Included in this
organic growth, network revenue increased 20%, dictation revenue
increased 26% primarily as a result of the release of Dragon
NaturallySpeaking version 9.0, while embedded revenue increased
by 37% and imaging revenue increased by 6%.
Based on the location of the customers, the geographic split in
fiscal 2006 was 74% of total revenue in the United States and
26% internationally. This compares to 69% of total revenue in
the United States and 31% internationally for the year ended
September 30, 2005. The increase in revenue generated in
the United States was primarily due to sales of Dictaphone
products, 93.0% of which revenue is derived in in the United
States. Excluding the Dictaphone revenue for fiscal 2006, 68% of
total revenue was derived from customers in the United States
and 32% internationally.
Fiscal
2005 Compared to Fiscal 2004
Total revenue for fiscal 2005 increased by $101.5 million
as compared to fiscal 2004. The increase in revenue was due to
several factors, including a twelve-month fiscal period in 2005,
which included a seasonally strong fourth calendar quarter that
contributed $60.6 million of total revenue. Excluding that
incremental quarter, total revenue increased $40.9 million,
or 31.2%. The substantial majority of the growth derived from
comparative periods due to organic growth in product lines
existing as of January 1, 2004 and to a lesser extent based
on revenue related to acquisitions consummated in late fiscal
2004 and during fiscal 2005.
The geographic revenue split, based on the location of our
customers, was 69% of total revenue in fiscal 2005 in the United
States and 31% internationally. This compares to 70% of total
revenue in the United States and 30% internationally for the
nine month period ended September 30, 2004.
Product and licensing revenue primarily consists of sales and
licenses of our speech and imaging products and technology. The
following table shows product and licensing revenue in absolute
dollars and as a percentage of total revenue (in thousands,
except percentages):
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Fiscal
2006 Compared to Fiscal 2005
Product and licensing revenue for fiscal 2006 increased by
$64.6 million compared to fiscal 2005. This increase in
product and licensing revenue was primarily due to
$39.8 million of revenue attributable to our acquisitions
of Former Nuance and Dictaphone. Excluding the impact of these
acquisitions, product and licensing revenue grew
$24.8 million, or 15%, compared to the fiscal year ended
September 30, 2005. Due to a change in revenue mix, driven
primarily by the growth of maintenance and support revenue,
product and licensing revenue as a percentage of total revenue
declined 13% in fiscal 2006 as compared to fiscal 2005.
Speech related product and licensing revenue increased 56% in
fiscal 2006 compared to fiscal 2007, growing to 70% of total
product and licensing revenue in fiscal 2006, up from 60% in
fiscal 2005. Excluding revenue due to our acquisitions of Former
Nuance and Dictaphone, speech related product and licensing
revenue increased by $19.6 million, or 19%, in fiscal 2006
compared to fiscal 2005. The growth in speech revenue resulted
from increased sales of our legacy network products, embedded
products in automotive and handsets, as well as increased sales
in dictation fueled by our fourth quarter release of Dragon
NaturallySpeaking 9.0. Product and licensing revenue from our
imaging products increased by $5.2 million, or 8%, due to
increased sales of our PDF product family with the September
2006 release of PDF 4.0 and the May 2006 release of PaperPort 11.
Fiscal
2005 Compared to Fiscal 2004
Product and licensing revenue for fiscal 2005 increased by
$72.9 million compared to fiscal 2004. The increase in
product and licensing revenue is generally attributable to the
factors discussed above with respect to total revenue, including
the seasonably strong fourth calendar quarter of calendar 2004
that contributed $46.8 million of increased product and
licensing revenue. Excluding the revenue from the additional
three-month period, product and licensing revenue increased
$26.1 million, or 26.6%. The substantial majority of the
growth in addition to the additional three months was growth
from organic products that we had in our product portfolio as of
January 1, 2004, and to a lesser extent was based on
revenue related to recent acquisitions. Speech related product
and licensing revenue increased to 60% of total product and
licensing revenue for fiscal 2005, up from 55% of total product
and licensing revenue in fiscal 2004. Expressed in dollars,
revenue from speech related products totaled $104.2 million
for fiscal 2005, as compared to $54.6 million for fiscal
2004. Within speech, network revenue remained relatively stable
at 25% of total product and licensing revenue in fiscal 2005,
while embedded revenue increased to 10% of total product and
licensing revenue in fiscal 2005, up from 7% in fiscal 2004. The
increase in embedded revenue was largely attributable to the
acquisition of ART in January 2005. Dictation revenue in fiscal
2005 increased to 25% of total product and licensing revenue, up
from 22% for fiscal 2004, primarily due to the release of Dragon
NaturallySpeaking 8.0 in the first quarter of fiscal 2005, as
well as the May 2005 acquisition of MedRemote.
Imaging related product and licensing revenue increased to
$66.9 million for fiscal 2005, up 53% from fiscal 2004. Of
this increase, 33% is due to the additional three months
included in fiscal 2005, with the majority of the remaining
increase attributable to increased sales of our PaperPort
product family, which had a new release in the first quarter of
fiscal 2005.
Professional services revenue primarily consists of consulting,
implementation and training services for speech customers.
Subscription and hosting revenue primarily relates to delivering
hosted and
on-site
directory assistance and transcription and dictation services
over a specified term. The following table shows professional
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services, subscription and hosting revenue in absolute dollars
and as a percentage of total revenue (in thousands, except
percentages):
Fiscal
2006 Compared to Fiscal 2005
Professional services, subscription and hosting revenue for
fiscal 2006 increased by $34.0 million as compared to
fiscal 2005. The largest component of this increase in
professional services revenue was $22.0 million of revenue
due to our acquisitions of Former Nuance and Dictaphone.
Included in the Dictaphone revenue is $16.0 million of
revenue relating to the subscription and hosting customer base.
Excluding the impact of these acquisitions, our professional
services revenue increased by $12.0 million, or 26%
compared to fiscal 2005, with most product lines contributing to
this growth. Network services, excluding revenue attributable to
Former Nuance, provided $9.0 million, or 26% organic
growth, based on growth in core network consulting, subscription
and hosting and training revenue.
Fiscal
2005 Compared to Fiscal 2004
Professional services, subscription and hosting revenue for
fiscal 2005 increased by $22.0 million as compared to
fiscal 2004. The increase in professional services revenue was
partially attributed to the inclusion of the seasonably strong
fourth calendar quarter of calendar 2004 that contributed
$11.0 million of increased professional services revenue.
In addition to the revenue from that extra three-month period,
professional services revenue increased $11.0 million, or
43%. The substantial majority of the growth was derived from
organic growth in products existing as of January 1, 2004
and a lesser portion was attributable to acquisitions made in
fiscal 2005. The organic growth is primarily due to the
continued demand for consulting services, both in project size
and in the volume of projects. Also contributing to the total
growth, but to a lesser extent, was revenue from subscription
based licensing and hosting services.
Maintenance and support revenue primarily consists of technical
support and maintenance service for our speech products
including network, embedded and dictation and transcription
products. The following table shows maintenance and support
revenue in absolute dollars and as a percentage of total revenue
(in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Maintenance and support revenue increased by $57.5 million
in fiscal 2006 compared to fiscal 2005. As a percentage of total
revenue, maintenance and support revenue grew 12.4% in fiscal
2006, up from 6% in fiscal 2005. $50.5 million of this
increase is due to our acquisitions of Former Nuance and
Dictaphone, both of which have a significant customer base of
maintenance and support contracts from historic sales of
product. Excluding the impact of these acquisitions, maintenance
and support revenue increased $7.0 million, or 50%, in
fiscal 2006 compared to fiscal 2005, due to our continued strong
renewal rates as well as from new sales in our network products.
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Fiscal
2005 Compared to Fiscal 2004
Maintenance and support revenue for fiscal 2005 increased by
$6.6 million compared to fiscal 2004. $2.8 million of
this increase is attributable to the additional three months
included in fiscal 2005. Excluding that incremental quarter,
maintenance and support revenue increased $3.3 million, or
45%. The substantial majority of the growth derived from
comparative periods was the result of organic growth in product
lines existing as of January 1, 2004, and to a lesser
extent the acquisitions consummated in late fiscal 2004 and
during fiscal 2005.
In fiscal 2006, stock-based compensation includes the
amortization of the fair value of share-based payments made to
employees and to members of our Board of Directors, under the
provisions of SFAS 123R, which we adopted on
October 1, 2005 (see Note 2, Summary of Significant
Accounting Policies, in the accompanying Notes to Consolidated
Financial Statements included in this Annual Report on
Form 10-K).
As a result of the adoption of SFAS 123R, we have recorded
$22.5 million of expense related to share-based payments
during fiscal 2006 as compared to $3.0 million in fiscal
2005 and $1.5 million in fiscal 2004. To isolate the
effects of the accounting change and to facilitate comparative
review of our operations between the fiscal 2006, fiscal 2005
and fiscal 2004 periods, we have presented below each cost and
expense line in tabular format, with and without the amounts
recorded in each period relating to share-based payments. Unless
noted otherwise, discussion of fiscal 2006 compared to fiscal
2005 represents discussion of costs and expenses excluding
share-based payments.
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 including and
excluding the cost of product and licensing revenue attributable
to stock-based compensation, in absolute dollars and as a
percentage of product and licensing revenue (in thousands,
except percentages):
Fiscal
2006 Compared to Fiscal 2005
Cost of product and licensing revenue, excluding share-based
payments, for fiscal 2006 increased $10.9 million as
compared to fiscal 2005 primarily due to $9.3 million of
costs due to our acquisitions of Former Nuance and Dictaphone.
As a percentage of product and licensing revenue, cost of
product and licensing revenue increased 1.4% in fiscal 2006,
largely due to Dictaphone products that have higher cost of
goods sold relative to our other products. The added costs of
goods sold for Dictaphone products are primarily due to third
party hardware that is included in the solutions licensed to
customers.
Excluding Dictaphone, in fiscal 2006 the cost of product and
licensing revenue increased by $1.9 million, while
declining to 9.2% of product and licensing revenue. The decrease
as a percent of revenue was due to several factors. Most
notably, the materials costs decreased by 0.7%, to 3.9% of
product and licensing revenue, due to a decrease in imaging
boxed products relative to speech products which carry lower
materials costs. Additionally,
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royalties decreased by $0.5 million compared to fiscal 2005
driven largely by contractual changes for our embedded product
lines’ royalties.
Fiscal
2005 Compared to Fiscal 2004
Cost of product and licensing revenue for fiscal 2005 grew
$10.0 million compared to fiscal 2004. This 96.9% increase
is due to a number of factors, most significant of which is the
additional three months included in 2005 as compared to 2004.
Additionally, the expenses have increased along with the 75.2%
growth in product and licensing revenue as compared to fiscal
2004. As a percentage of product and licensing revenue, cost of
product and licensing revenue for fiscal 2005 increased to 11.9%
as compared to 10.6% in fiscal 2004. This increase is primarily
due to higher third party royalty expense that amounted to
$4.2 million for fiscal 2005, compared to $1.2 million
in fiscal 2004. The $3.0 million increase is due to a
number of factors including more products that have royalties
associated with them, higher royalties associated with
renegotiated contracts with third parties for certain imaging
products, and the 75.2% increase in product and licensing
revenue. Partially offsetting the royalty increase was a modest
decrease in material costs of product and licensing revenue,
from 5.0% of product and licensing revenue in fiscal 2004 to
4.6% for fiscal 2005.
Cost of professional services, subscription 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 subscription and hosted
solutions. The following table shows cost of revenue including
and excluding the cost of revenue attributable to stock-based
compensation, in absolute dollars and as a percentage of
professional services, subscription and hosting revenue (in
thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Cost of professional services, subscription and hosting revenue,
excluding share-based payments, increased $22.5 million in
fiscal 2006 as compared to fiscal 2005 primarily due to
$14.9 million of costs due to our acquisitions of Former
Nuance and Dictaphone, both of which have robust professional
services organizations to support revenue streams. Additionally,
Dictaphone has a large subscription-based licensing and hosted
application customer base. The 65.0% growth in costs supports
the 71.9% growth in related revenue for fiscal 2006. Cost of
professional services as a percentage of the revenue, excluding
share-based payments, improved 2.9% as synergies were realized
from the merging of the service teams from Former Nuance and
Dictaphone. These improvements were offset partially by
increased expenses for the subscription and hosting services.
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Fiscal
2005 Compared to Fiscal 2004
Cost of professional services, subscription and hosting revenue
for fiscal 2005 increased $14.2 million compared to fiscal
2004. This increase was due to a number of factors including the
additional three months included in fiscal 2005. Additionally,
incremental costs were necessary to support the 86.6% growth in
related revenue. As a percentage of the related revenue, cost of
professional services, subscription and hosting revenue for
fiscal 2005 decreased to 73.2% compared to 80.4% in fiscal 2004.
The percentage decrease in professional services cost as a
percent of professional services revenue is attributable to a
number of factors, including a reduction in outside consultant
expenses and a more efficient utilization of existing headcount.
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
including and excluding the cost of maintenance and support
revenue attributable to stock-based compensation, in absolute
dollars and as a percentage of maintenance and support revenue
(in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Cost of maintenance and support revenue, excluding share-based
payments, for fiscal 2006 increased $12.3 million compared
to fiscal 2005 due primarily to $8.0 million of costs for
the additional headcount to support the additional revenue from
our acquisitions of Former Nuance and Dictaphone. As a
percentage of maintenance and support revenue, cost of revenue
decreased 11.4% in fiscal 2006 to 24.1%. This decrease in
percentage is primarily attributable to lower costs relative to
the revenue in our healthcare maintenance and support business
following our acquisition of Dictaphone. Speech margins,
excluding the acquisition of Dictaphone, also improved in fiscal
2006, primarily due to synergies we realized upon the
combination of pre-existing and acquired product lines following
our acquisition of Former Nuance.
Fiscal
2005 Compared to Fiscal 2004
Cost of maintenance and support revenue for fiscal 2005 grew
$2.4 million as compared to fiscal 2004. This increase was
due to a number of factors including the additional three months
included in fiscal 2005. Additionally, incremental costs were
necessary to support the 79.6% growth in related revenue. As a
percentage of maintenance revenue, cost of maintenance revenue
increased 2.5% in fiscal 2005 as compared to fiscal 2004. The
percentage increase was attributable to increased staffing made
in advance of the anticipation of increasing revenue.
Cost of revenue from amortization of intangible assets consists
of the amortization of acquired patents and core and completed
technology using the straight-line basis over their estimated
useful lives. We evaluate the recoverability of intangible
assets periodically or whenever events or changes in business
circumstances indicate that the carry value of our intangible
assets may not be recoverable. The following table shows cost of
revenue from
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amortization of intangible assets in absolute dollars and as a
percentage of total revenue (in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Cost of revenue from amortization of intangible assets increased
$3.8 million in fiscal 2006 as compared to fiscal 2005. The
increase was primarily attributable to the $4.4 million in
amortization of intangible assets acquired in connection with
our acquisitions of Dictaphone in March 2006 and Former Nuance
in September 2005. Additionally, the increase was due to
$0.4 million in expense relative to amortization of the
license that resulted from our December 4, 2006 settlement
and licensing of technology from z4 Technologies, Inc. (refer to
Note 23 of Notes to our Consolidated Financial Statements
for discussion of this subsequent event). In addition, during
the fourth quarter of fiscal 2006, we determined that we would
not make additional investments to support a technology licensed
from a non-related third-party in 2003. As a result, we revised
the cash flow estimates related to the purchased technology and
recorded an additional $2.6 million in cost of revenue to
write down the purchased technology to its net realizable value.
These increases were offset in part by the cessation of the
amortization of technology and patents that was established in
connection with our acquisitions consummated in 1999 and 2000.
Based on the amortizable intangible assets as of
September 30, 2006, and assuming no impairment or reduction
in expected lives, we expect cost of revenue from amortization
of intangible assets for fiscal 2007 to be $11.2 million.
Fiscal
2005 Compared to Fiscal 2004
Cost of revenue from amortization of intangible assets increased
$0.7 million in fiscal 2005 as compared to fiscal 2004. The
increase was attributable to the additional three months
included in the fiscal 2005 period, partially offset by the net
amount of amortization of intangible assets that became fully
amortized in fiscal 2004 and new amortization on assets
established in connection with our acquisitions during fiscal
2004 and 2005.
Research and development expense primarily consists of salaries
and benefits and overhead relating to our engineering staff. The
following table shows research and development expense including
and excluding the research and development expense attributable
to share-based payments, in absolute dollars and as a percentage
of total revenue (in thousands, except percentages):
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Fiscal
2006 Compared to Fiscal 2005
Research and development expense, excluding share-based
payments, increased $15.9 million in fiscal 2006 compared
to fiscal 2005 primarily due to a $12.9 million increase in
compensation related expense associated with increased average
headcount of 80 employees mainly resulting from our acquisitions
of Former Nuance and Dictaphone. The remaining increase was
attributable to an increase in other headcount related expenses,
including travel and infrastructure related expenses as we
continued to invest in our products. While continuing to
increase in absolute dollars, research and development expense
has decreased relative to our total revenue. This decrease in
expense as a percentage of total revenue reflects synergies
following previous acquisitions.
We believe that the development of new products and the
enhancement of existing products are essential to our success.
Accordingly, we plan to continue to invest in research and
development activities. To date, we have not capitalized any
internal development costs as the cost incurred after
technological feasibility but before release of products has not
been significant. While we will continue to invest in research
and development in fiscal 2007, we expect research and
development expenses to decline as a percentage of revenue.
Fiscal
2005 Compared to Fiscal 2004
Research and development expense, excluding share-based
payments, increased $12.8 million in fiscal 2005 as
compared to fiscal 2004. The increase in expenses after
reflecting the effect of the three months ended December 2004 in
fiscal 2004, results in additional expenses of
$3.9 million, or 11% in fiscal 2005 as compared to fiscal
2004 on an annualized basis. While increasing in absolute
dollars, research and development expense decreased relative to
our total revenue. This decrease in expense as a percentage of
total revenue reflects synergies following previous acquisitions.
Sales and marketing expense includes salaries and benefits,
commissions, advertising, direct mail, public relations,
tradeshows and other costs of marketing programs, travel
expenses associated with our sales organization and overhead.
The following table shows sales and marketing expense including
and excluding the sales and marketing expense attributable to
share-based payments, in absolute dollars and as a percentage of
total revenue (in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Sales and marketing expense, excluding share-based payments,
increased $43.2 million in fiscal 2006 as compared to
fiscal 2005. $34.7 million of this increase was
attributable to an increase in salaries and other variable
costs, commissions and travel expenses relating to an increase
in average headcount of 207 employees primarily resulting from
our acquisitions of Former Nuance and Dictaphone and continued
investment in the sales force for our existing products. In
addition, our marketing expenses increased $7.8 million
primarily to support new product releases made during 2006,
including PaperPort 11 and Dragon Naturally Speaking 9.0, as
well as additional marketing expenses of Dictaphone and Former
Nuance products. While the expense in absolute dollars
increased,
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sales and marketing expense as a percentage of revenue decreased
as we achieved higher sales volumes while controlling our cost
structure.
We expect sales and marketing expenses to increase as we
continue to pursue our strategic goals. While increasing in
absolute dollars, we expect to see a decrease in sales and
marketing expenses as a percentage of revenue in fiscal 2007 as
the expected revenue growth outpaces the expenses in this area.
Fiscal
2005 Compared to Fiscal 2004
Sales and marketing expense, excluding share-based payments,
increased $28.8 million in fiscal 2005 compared to fiscal
2004. The increase in expenses after reflecting the effect of
the three months ended December 2004, resulted in additional
expenses of $10.2 million, or 15% in fiscal 2005 compared
to fiscal 2004 on an annualized basis. While increasing in
absolute dollars, sales and marketing expense as a percent of
total revenue dropped 4.0% in fiscal 2005 compared to fiscal
2004. Decreases in expenses as a percent of revenue were derived
largely from an improved efficiency of the sales organization,
allowing for total compensation of sales and marketing employees
to decrease as a percentage of revenue, to 18.9% of total
revenue for fiscal 2005, down from 21.1% for fiscal 2004.
Additionally, while the cost of marketing programs increased in
absolute dollars to $16.9 million for fiscal 2005 from
$10.7 million for fiscal 2004, this represents a decrease
in terms of the percentage compared to total revenue of 0.9%,
from 8.2% in fiscal 2004 to 7.3% in fiscal 2005.
General and administrative expenses primarily consist of
personnel costs, (including overhead), 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 including and excluding the general and
administrative expense attributable to share-based payments, in
absolute dollars and as a percentage of total revenue (in
thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
General and administrative expense, excluding share-based
payments, increased $17.7 million in fiscal 2006 compared
to fiscal 2005. The acquisition of Dictaphone contributed
$7.7 million of this increase, including $3.0 million
paid to Dictaphone staff for non-recurring activities necessary
to transition knowledge and processes post-acquisition and
$0.8 million in non-recurring activities performed by
certain advisors who supported planning and integration efforts
for this acquisition. General and administrative expenses,
excluding those related to Dictaphone, increased
$10.0 million due primarily to compensation for increased
employees and external contractors in the finance, human
resources, legal and other general and administrative functions.
This increase in spending on staff and contractors was related
to the integration of the acquisitions we made in fiscal 2005,
as well as to compliance with new regulations, such as the
implementation of SFAS 123R in fiscal 2006. These new
initiatives were partially offset by a reduction in overall
costs for staffing and contractors needed to comply with the
provisions of Sarbanes Oxley in fiscal 2006 compared to fiscal
2005. While the expense increased in absolute
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dollars, general and administrative expense as a percentage of
revenue decreased as we achieved higher sales volumes while
controlling our cost structure.
We expect to continue to see general and administrative expenses
as a percentage of total revenue decrease as revenue growth
outpaces expense growth. Notwithstanding the decrease as a
percentage of total revenue, we expect to increase the total
amount expended relating to general and administrative expenses
as we support the growth of our business.
Fiscal
2005 Compared to Fiscal 2004
General and administrative expense, excluding share-based
payments, increased $13.6 million in fiscal 2005 compared
to fiscal 2004. The increase in expenses after reflecting the
effect of the three months ended December 2004 in fiscal 2004,
results in additional expenses of $6.3 million, or 24.7% in
fiscal 2005 as compared to fiscal 2004 on an annualized basis.
The increase in fiscal 2005 was primarily the result of costs
relating to incremental headcount and fees for professional
consultants. The costs relating to headcount were mainly
attributable to additional team members in the finance,
facilities and IT departments. The increase in expenditures for
professional consultants includes fees for Sarbanes Oxley
compliance, accounting and legal advisors, and advisors
supporting our planning and integration efforts related to our
acquisition of Former Nuance.
Amortization of other intangible assets into operating expense
includes amortization of acquired customer and contractual
relationships, non-competition agreements and acquired trade
names and trademarks. Customer relationships are amortized on an
accelerated basis based upon the pattern in which the economic
benefit of customer relationships are being utilized. Other
identifiable intangible assets are amortized on a straight-line
basis over their estimated useful lives. We evaluate these
assets for impairment and for appropriateness of their remaining
life on an ongoing basis. The following table shows amortization
of other intangible assets in absolute dollars and as a
percentage of total revenue (in thousands, except percentages):
Fiscal
2006 Compared to Fiscal 2005
Amortization of intangible assets increased $13.2 million
in fiscal 2006 as compared to fiscal 2005 largely attributable
to the $10.8 million of amortization of identifiable
intangible assets related to our acquisition of Dictaphone and
full year amortization relating to our acquisitions of Former
Nuance, Rhetorical, ART, Phonetic and MedRemote acquisitions.
Based on the amortizable intangible assets as of
September 30, 2006, and assuming no impairment or reduction
in expected lives, we expect that the fiscal 2007 amortization
included in operating expenses will be $20.4 million.
Fiscal
2005 Compared to Fiscal 2004
Operating expenses derived from the amortization of intangible
assets increased $2.0 million in fiscal 2005 as compared to
fiscal 2004. The increase relates to the additional three months
included in fiscal 2005, and to the amortization of intangible
assets that were purchased in connection with our acquisitions
during fiscal 2004 and 2005.
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During the second quarter of fiscal 2006, we recorded a
$1.3 million reduction to existing restructuring reserves
as a result of the execution of a favorable sublease agreement
relating to one of the facilities included in our 2005
restructuring plan. The amount was partially offset by other net
adjustments of $0.1 million associated with prior
years’ restructuring programs.
In fiscal 2005, we incurred restructuring charges of
$7.2 million. The charges were related to the elimination
of ten employees during the first quarter of 2006, a plan of
restructuring relative to certain of our facilities in June
2005, and a September 2005 plan of restructuring to eliminate
additional facilities and a reduction of approximately 40
employees in connection with our acquisition of Former Nuance.
The facilities charges included $0.2 million related to the
write-down of leasehold improvements based on their net book
value relative to the fair market value for their shortened
lives. The reduction in personnel was primarily from the
research and development and sales and marketing teams, and was
based on the elimination of redundancies resulting from our
acquisition of Former Nuance.
The following table sets forth the activity relating to the
restructuring accruals in fiscal 2006, 2005 and 2004
(in thousands):
The remaining personnel related accrual as of September 30,
2006 is primarily composed of amounts due under the 2005
restructuring plans which will be paid in fiscal 2007.
The following table shows other income (expense), net in
absolute dollars and as a percentage of total revenue (in
thousands, except percentages):
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Fiscal
2006 Compared to Fiscal 2005
Interest income increased $2.1 million in fiscal 2006, as
compared to fiscal 2005, primarily due to higher cash and
investment balances during fiscal 2006, as compared to the prior
year, and to a lesser degree to greater yields on our cash and
investments. Interest expense increased by $16.0 million
during fiscal 2006, as compared to fiscal 2005, mainly due to
$12.2 million of interest expense paid quarterly on the new
credit facility we entered into on March 31, 2006.
Additionally, we have recorded $4.6 million of non-cash
interest expense mainly related to imputed interest in
association with certain lease obligations included in our
accrued business combination costs and accrued restructuring
charges, the amortization of debt issuance costs associated with
the new credit facility we entered into on March 31, 2006
as well as to the accretion of the interest related to the note
payable from our Phonetic acquisition in February 2005. Other
income (expense) principally consisted of foreign exchange gains
(losses) as a result of the changes in foreign exchange rates on
certain of our foreign subsidiaries whose operations are
denominated in other than their local currencies, as well as the
translation of certain of our intercompany balances.
We expect interest expense to increase in during fiscal 2007,
relative to fiscal 2006, as we pay interest on the 2006 credit
facility, and amortize the debt issuance costs, for the full
year as compared to the six month period that the debt was
outstanding in fiscal 2006. We will continue to record interest
expense as it relates to certain lease obligations included in
our accrued restructuring and accrued business combination costs.
Fiscal
2005 Compared to Fiscal 2004
Interest income increased $0.8 million in fiscal 2005, as
compared to fiscal 2004, primarily attributable to higher cash
and investment balances during the year. Interest expense
increased $1.3 million in fiscal 2005, as compared to
fiscal 2004, mainly due to the recognition of non cash interest
expense in association with the deferred installment payments of
$16.4 million and $17.5 million, respectively, in
connection with our acquisitions of ART and Phonetic during the
second quarter of fiscal 2005.
The following table shows the provision for income taxes in
absolute dollars and the effective income tax rate (in
thousands, except percentages):
The variance from the federal statutory rate in all periods was
due primarily to the increase in our valuation allowance with
respect to certain deferred tax assets. Valuation allowances
have been established for the U.S. net deferred tax asset, which
we believe do not meet the “more likely than not”
realization criteria established by SFAS 109,
“Accounting for Income Taxes.” Due to a history of
cumulative losses in the United States, a full valuation
allowance has been recorded against the net deferred assets of
our U.S. entities. At September 30, 2006, we had a
valuation allowance for U.S. net deferred tax assets of
approximately $312.1 million. The U.S. net deferred tax
assets is composed of tax assets primarily related to net
operating loss carryforwards (resulting both from business
combinations and from operations) and tax credits, offset by
deferred tax liabilities primarily related to intangible assets.
Certain of these intangible assets have indefinite lives, and
the resulting deferred tax liability associated with these
assets is not allowed as an offset to our deferred tax assets
for purposes of determining the required amount of our valuation
allowance.
Our utilization of deferred tax assets that were acquired in a
business combination (primarily net operating loss
carryforwards) results in a reduction in the associated
valuation allowance and an increase to goodwill. Our
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establishment of new deferred tax assets as a result of
operating activities requires the establishment of valuation
allowances based upon the SFAS 109 “more likely than
not” realization criteria. The establishment of a valuation
allowance relating to operating activities is recorded as an
increase to tax expense.
Our tax provision also includes state and foreign tax expense,
which is determined on either a legal entity or separate tax
jurisdiction basis.
Cash and cash equivalents totaled $112.3 million as of
September 30, 2006, an increase of $16.5 million
compared to $95.8 million including marketable securities
of $24.1 million as of September 30, 2005. In
addition, we had $0.8 million and $11.7 million of
certificates of deposit relating to certain of our facilities
leases as of September 30, 2006 and 2005, respectively. We
completed fiscal 2006 with working capital of $51.3 million
as compared to $12.1 million in fiscal 2005. As of
September 30, 2006, total retained deficit was
$190.1 million. We do not expect our retained deficit will
impact our future ability to operate given our strong cash and
financial position. Our cash and cash equivalents increased by
$40.6 million in fiscal 2006. This increase was composed of
cash provided by operating activities of $47.9 million,
partially offset by the net impact of cash provided by financing
activities and cash used in investing activities.
Cash provided by operating activities for fiscal 2006 was
$47.9 million, an increase of $31.7 million, or 196%,
from $16.2 million provided by operating activities in
fiscal 2005. The increase was primarily composed of changes
relating to the net loss after adding back non-cash items such
as depreciation and amortization, and share-based compensation;
in fiscal 2006 this amount was $54.9 million compared to
$20.9 million in fiscal 2005, an increase of
$34.0 million, or 163%. This increase was offset by changes
in working capital of $2.3 million, of which an
$8.7 million use of cash for non-Dictaphone operations was
offset by $6.4 million source of cash due to changes in
Dictaphone working capital. The change in non-Dictaphone working
capital was due to improved billing and collection processes
resulting in improved days outstanding for accounts receivable
billings. The Dictaphone working capital was also positive due
to the collection of accounts receivable and acquired unbilled
accounts receivable. For both non-Dictaphone and Dictaphone
working capital, the cash provided from net accounts receivable
was offset by payments relative to accounts payable and accrued
expenses, a net decrease in deferred revenue, and a net increase
in prepaid and other assets. Deferred revenue of Dictaphone and
non-Dictaphone decreased largely due to amounts that were
included in the beginning balance sheet relating to customer
contracts also included in acquired unbilled accounts
receivable, including the deferred revenue accounts of Former
Nuance in the case of the non-Dictaphone changes.
Cash provided by operating activities for fiscal 2005 was
$16.2 million, an increase of $9.9 million or 159%, as
compared to $6.3 million in fiscal 2004. The increase in
cash from operations was primarily due to a decrease in net loss
by $4.0 million, increased non-cash items including an
increase of $4.8 million in depreciation and amortization
expense and an increase in deferred tax provision of
$2.1 million. Also contributing to the increase in cash
from operations was an increase in accounts payable, accrued
expenses and deferred revenue totaling $19.2 million,
offset by a $24.8 million growth in accounts receivable
driven by our revenue growth of 77.5% in fiscal 2005.
Cash used in investing activities for fiscal 2006 was
$366.0 million, an increase of $321.4 million, or
721%, as compared to $44.6 million for fiscal 2005. The
increase in cash used in investing was primarily driven by an
increase of $331.5 million in cash paid for our
acquisitions, of which the majority of the fiscal 2006 payments
related to our acquisition of Dictaphone on March 31, 2006.
$3.8 million of the increase related to incremental
additions to property and equipment. The increase in cash used
in investing activities was partially offset by an
$11.1 million decrease in restricted cash and
$3.1 million of incremental maturities of marketable
securities.
Cash used in investing for fiscal 2005 was $44.6 million,
an increase of $15.9 million, or 55.3%, as compared to
$28.7 million in fiscal 2004. The increase in cash used in
investing was primarily driven by an increase of
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$60.6 million in cash paid relating to various acquisitions
during fiscal 2005 and $1.3 million increase in additions
to property and equipment. These increases were partially offset
by $21.1 million of cash proceeds from maturities of
marketable securities.
Cash provided by financing activities for fiscal 2006 was
$358.6 million, an increase of $282.1 million compared
to $76.5 million in fiscal 2005. The increase in cash
provided by financing activities was primarily driven by
$346.0 million net proceeds from the new credit facility we
entered into in March 2006. Additionally, the proceeds from the
issuance of common stock under employee based compensation plans
increased $24.6 million, or 397%. These increases were
partially offset by $73.8 million in net proceeds from the
issuance of common stock under private placements that occurred
in fiscal 2005 and deferred acquisition payments of
$14.4 million related to our acquisition of ART in fiscal
2005.
Cash provided by financing activities for fiscal 2005 was
$76.5 million, an increase of $73.8 million compared
to $2.7 million in fiscal 2004. The increase in financing
activities was driven by net cash proceeds of $73.9 million
from the issuance of stock and warrants in a private equity
offering during fiscal 2005.
On March 31, 2006 we entered into a new senior secured
credit facility, the 2006 Credit Facility. The 2006 Credit
Facility consists of a $355.0 million,
7-year term
loan which matures on March 31, 2013 and a
$75.0 million revolving credit line which matures on
March 31, 2012. The available revolving credit line
capacity is reduced, as necessary, to account for letters of
credit outstanding. As of September 30, 2006, there were
$17.2 million of letters of credit issued under the
revolving credit line and there were no outstanding borrowings
under the revolving credit line.
Borrowings under the 2006 Credit Facility bear interest at a
rate equal to the applicable margin plus, at our option, either
(a) a base rate (which is the higher of the corporate base
rate of UBS AG, Stamford Branch, or the federal funds rate plus
0.50% per annum) or (b) a LIBOR rate determined by
reference to the British Bankers’ Association Interest
Settlement Rates for deposits in U.S. dollars. The
applicable margin for borrowings under the 2006 Credit Facility
ranges from 0.50% to 1.00% per annum with respect to base
rate borrowings and from 1.50% to 2.00% per annum with
respect to LIBOR-based borrowings, depending upon our leverage
ratio. As of September 30, 2006, our applicable margin is
1.00% for base rate borrowings and 2.00% for LIBOR-based
borrowings. We are required to pay a commitment fee for
unutilized commitments under the revolving credit facility at a
rate ranging from 0.375% to 0.50% per annum, based upon our
leverage ratio. As of September 30, 2006, our commitment
fee rate is 0.50%.
We capitalized approximately $9.0 million in debt issuance
costs related to the opening of the 2006 Credit Facility. The
costs associated with the revolving credit facility are being
amortized as interest expense over six years, through March
2012, while the costs associated with the term loan are being
amortized as interest expense over seven years, through March
2013, which is the maturity date of the revolving line and term
facility, respectively under the 2006 Credit Facility. The
effective interest rate method is used to calculate the
amortization of the debt issuance costs for both the revolving
credit facility and the term loan. These debt issuance costs,
net of accumulated amortization of $0.7 million, are
included in other assets in the consolidated balance sheet as of
September 30, 2006.
The $355.0 million term loan is subject to repayment
consisting of a baseline amortization of 1% per annum
($3.55 million per year, due in four equal quarterly
installments), and an annual excess cash flow sweep, as defined
in the 2006 Credit Facility, which will be first payable
beginning in the first quarter of fiscal 2008, based on the
excess cash flow generated in fiscal 2007. As of
September 30, 2006, we have repaid $1.8 million of
principal under the term loan agreement. Any borrowings not paid
through the baseline repayment, the excess cash flow sweep, or
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any other mandatory or optional payments that we may make, will
be repaid upon maturity. If only the baseline repayments are
made, the aggregate annual maturities of the term loan would be
as follows (in thousands):
Our obligations under the 2006 Credit Facility are
unconditionally guaranteed by, subject to certain exceptions,
each of our existing and future direct and indirect wholly-owned
domestic subsidiaries. The 2006 Credit Facility and the
guarantees thereof are secured by first priority liens and
security interests in the following: 100% of the capital stock
of substantially all of our domestic subsidiaries and 65% of the
outstanding voting equity interests and 100% of the non-voting
equity interests of first-tier foreign subsidiaries, material
tangible and intangible assets, and present and future
intercompany debt. The 2006 Credit Facility also contains
provisions for mandatory prepayments of outstanding term loans,
subject to certain exceptions, with: 100% of net cash proceeds
of asset sales, 100% of net cash proceeds of issuance or
incurrence of debt, and 100% of extraordinary receipts. We may
voluntarily prepay the 2006 Credit Facility without premium or
penalty other than customary “breakage” costs with
respect to LIBOR-based loans.
The 2006 Credit Facility contains a number of covenants that,
among other things, restrict, subject to certain exceptions, our
ability to: incur additional indebtedness, create liens on
assets, enter into certain sale and lease-back transactions,
make investments, make certain acquisitions, sell assets, engage
in mergers or consolidations, pay dividends and distributions or
repurchase our capital stock, engage in certain transactions
with affiliates, change the business conducted by us, amend
certain charter documents and material agreements governing
subordinated indebtedness, prepay other indebtedness, enter into
agreements that restrict dividends from subsidiaries and enter
into certain derivatives transactions. The 2006 Credit Facility
is governed by financial covenants that include, but are not
limited to, maximum total leverage and minimum interest coverage
ratios, as well as to a maximum capital expenditures limitation.
The 2006 Credit Facility also contains certain customary
affirmative covenants and events of default. As of
September 30, 2006, we were in compliance with the
covenants.
We believe that cash flows from future operations in addition to
cash and marketable securities on hand will be sufficient to
meet our working capital, investing, financing and contractual
obligations, including our settlement and licensing agreement
with z4 Technologies and our anticipated acquisition of
Mobile Voice Control, Inc., as they become due for the
foreseeable future. We also believe that in the event future
operating results are not as planned, that we could take
actions, including restructuring actions and other cost
reduction initiatives, to reduce operating expenses to levels
which, in combination with expected future revenue, will
continue to generate sufficient operating cash flow. In the
event that these actions are not effective in generating
operating cash flows we may be required to issue equity or debt
securities on less than favorable terms.
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Off-Balance
Sheet Arrangements, Contractual Obligations, Contingent
Liabilities and Commitments
Contractual
Obligations
The following table summarizes our outstanding contractual
obligations as of September 30, 2006 (in thousands):
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In addition to the $17.5 million due to the former
shareholders of Phonetic as described above, we also agreed to
make contingent payments of up to $35.0 million upon the
achievement of certain performance targets in accordance with
the purchase agreement. On June 1, 2006, we notified the
former shareholders of Phonetic that the performance targets for
the first scheduled payment of up to $12.0 million were not
achieved. The former shareholders of Phonetic have objected to
this determination. We are currently in an early stage of
discussions with the former shareholders of Phonetic in regards
to this matter.
In connection with the acquisition of Brand & Groeber
Communications GbR (“B&G”) in September 2004, we
agreed to make contingent payments that could amount to
€5.5 million based on the achievement of certain
performance targets. From the date of acquisition through
December 31, 2005, €0.4 million was paid based on
the attainment of certain performance targets. The remaining
€5.1 million (approximately $6.5 million based on
the currency exchange rates as of September 30, 2006) may
be earned based on the attainment of performance targets for
calendar 2006 and, to the extent earned, would be paid in
January 2007.
In connection with our acquisition of Dictaphone Corporation in
March 2006, we are committed to pay $1.2 million in
severance and related one-time payments to former employees of
Dictaphone so long as they remain with us through specified
dates in fiscal 2007. These $1.2 million in payments are
not accrued as of September 30, 2006, as they are related
to future performance obligations of these employees.
We have defined benefit pension plans that were assumed as part
of the acquisition of Dictaphone Corporation on March 31,
2006, which provide certain retirement and death benefits for
former Dictaphone employees located in the United Kingdom and
Canada. These plans require periodic cash contributions. The
Canadian plan is fully funded and expected to remain fully
funded during fiscal 2007, without additional funding by us. In
fiscal 2006, total cash funding for the UK pension plan was
$0.6 million. For the UK pension plan, we have a minimum
funding requirement of £859,900 (approximately
$1.6 million based on the exchange rate at
September 30, 2006) for each of the next 5 years,
through fiscal 2011.
We have also assumed a post-retirement health care and life
insurance benefit plan in connection with the acquisition of
Dictaphone Corporation. The plan, which is frozen, provides
certain post-retirement health care and life insurance benefits
and consists of a fixed subsidy for qualifying employees in the
United States and Canada. The plan is non-funded and cash
contributions are made each year to cover claim costs incurred
in that year. Total cash paid during fiscal 2006 for the
post-retirement health care and life insurance benefit plan was
not material.
Through September 30, 2006, we have not entered into any
off-balance sheet arrangements or material transactions with
unconsolidated entities or other persons.
CRITICAL
ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The preparation of financial statements in conformity with
U.S. generally accepted accounting principles, requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and
expenses during the reporting period. On an ongoing basis, we
evaluate our estimates, assumptions and judgments, including
those related to revenue recognition; allowance for doubtful
accounts and returns; accounting for patent legal defense costs;
the costs to complete the development of custom software
applications; the valuation of goodwill, other intangible assets
and tangible long-lived assets; accounting for acquisitions;
share-based payments; obligation relating to pension and
post-retirement benefit plans; interest rate
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swaps which are characterized as derivative instruments; income
tax reserves and valuation allowances; and loss contingencies.
Our management bases its estimates on historical experience and
various other factors that are believed to be reasonable under
the circumstances. Actual results could differ from these
estimates.
We believe the following critical accounting policies most
significantly affect the portrayal of our financial condition
and results of operations and require our most difficult and
subjective judgments.
Revenue Recognition: We recognize product and
licensing revenue in accordance with Statement of Position
(“SOP”)
97-2,
“Software Revenue Recognition,” and
SOP 98-9,
Modification of
SOP 97-2,
“Software Revenue Recognition, with Respect to Certain
Transactions,” and related authoritative literature. The
application of
SOP 97-2
requires judgment, including whether a software arrangement
includes multiple elements, and if so, whether vendor-specific
objective evidence (“VSOE”) of fair value exists for
those elements. Our software arrangements generally include
software and post contract support which includes telephone
support and the right to receive unspecified
upgrades/enhancements on a
when-and-if-available
basis, typically for one to three years. Changes to the elements
in a software arrangement, the ability to identify VSOE for
those elements and the fair value of the respective elements
could materially impact the amount of earned and unearned
revenue. Judgment is also required to assess whether future
releases of certain software represent new products or upgrades
and enhancements to existing products. In accordance with
SOP 97-2,
revenue is recognized when (i) persuasive evidence of an
arrangement exists, (ii) delivery has occurred,
(iii) the fee is fixed or determinable and
(iv) collectibility is probable.
Non-software revenue is recognized in accordance with, the
Securities and Exchange Commission’s Staff Accounting
Bulletin (“SAB”) 104, “Revenue Recognition in
Financial Statements.” Under SAB 104, we recognize
revenue when (i) persuasive evidence of an arrangement
exists, (ii) delivery has occurred or services have been
rendered, (iii) the fees are fixed or determinable and
(iv) collectibility is reasonably assured.
Professional services revenue is recognized in accordance with
SOP 81-1,
“Accounting for Performance of Construction Type and
Certain Performance Type Contracts” on the
percentage-of-completion
method. We generally determine the
percentage-of-completion
by comparing the labor hours incurred to date to the estimated
total labor hours required to complete the project. We consider
labor hours to be the most reliable, available measure of
progress on these projects. Adjustments to estimates to complete
are made in the periods in which facts resulting in a change
become known. When the estimate indicates that a loss will be
incurred, such loss is recorded in the period identified.
Significant judgments and estimates are involved in determining
the percent complete of each contract. Different assumptions
could yield materially different results.
We make estimate of sales returns based on historical
experience. In accordance with Statement of Financial Accounting
Standards (“SFAS”) 48, “Revenue Recognition When
Right of Return Exists,” the provision for these estimated
returns is recorded as a reduction of revenue and accounts
receivable at the time that the related revenue is recorded. We
also make estimates and reduce revenue recognized for price
protection and rebates, and certain marketing allowances at the
time the related revenue is recorded. If actual results differ
significantly from our estimates, such differences could have a
material impact on our results of operations for the period in
which the actual results become known.
Our revenue recognition policies require management to make
significant estimates. Management analyzes various factors,
including a review of specific transactions, historical
experience, creditworthiness of customers and current market and
economic conditions. Changes in judgments based upon these
factors could impact the timing and amount of revenue and cost
recognized and thus affects our results of operations and
financial condition.
Capitalized Patent Defense Costs: We monitor
the anticipated outcome of legal actions, and if we determine
that the success of the defense of a patent is probable, and so
long as we believe that the future economic benefit of the
patent will be increased, we then capitalize external legal
costs incurred in the defense of these patents, up to the level
of the expected increased future economic benefit. If changes in
the anticipated outcome occur, we write off any capitalized
costs in the period the change is determined. As of
September 30, 2006 and 2005, capitalized patent defense
costs totaled $6.4 million and $2.3 million,
respectively.
Research and Development Costs: We account for
the internal costs relating to research and development
activities in accordance with SFAS 2, “Accounting for
Research and Development Costs,” and SFAS 86,
“Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed.” Research and
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development costs incurred for new software products and
enhancements to existing products, other than certain software
development costs that qualify for capitalization, are expensed
as incurred. Software development costs incurred subsequent to
the establishment of technological feasibility, but prior to the
general release of the product, are capitalized and amortized to
cost of revenue over the estimated useful life of the related
products. Judgment is required in determining when technological
feasibility of a product is established. We have determined that
technological feasibility for our software products is reached
shortly before the products are released to manufacturing. Costs
incurred after technological feasibility is established have not
been material, and accordingly, we have expensed the internal
costs relating to research and development when incurred.
Purchased Computer Software: The cost of
purchased computer software to be sold, leased, or otherwise
marketed is capitalized if the purchased software has an
alternative future use. Otherwise, the cost is expensed as
incurred. Capitalized purchased computer software is amortized
to cost of revenue over the estimated useful life of the related
products. At each balance sheet date, we evaluate these assets
for impairment by comparing the unamortized cost to the net
realizable value. Amortization expense was $5.1 million,
$2.1 million and $1.6 million for fiscal 2006, 2005
and 2004, respectively. Included in the fiscal 2006 amortization
expense was an additional $2.6 million of expense
representing an impairment determined to exist in order to value
the purchased computer software at its net realizable value. See
Note 8 of the Notes to our Consolidated Financial
Statements. The net unamortized purchased computer software
included in other intangible assets at September 30, 2006
and 2005 were $1.6 million and $5.2 million,
respectively.
Valuation of Long-lived Tangible and Intangible Assets and
Goodwill: We have significant long-lived tangible
and intangible assets, including goodwill and intangible assets
with indefinite lives, which are susceptible to valuation
adjustments as a result of changes in various factors or
conditions. The most significant long-lived tangible and
intangible assets are fixed assets, patents and core technology,
completed technology, customer relationships and trademarks. All
finite-lived intangible assets are amortized based upon patterns
in which the economic benefits of customer relationships are
expected to be utilized. The values of intangible assets, with
the exception of goodwill and intangible assets with indefinite
lives, were initially determined by a risk-adjusted, discounted
cash flow approach. We assess the potential impairment of
identifiable intangible assets and fixed assets whenever events
or changes in circumstances indicate that the carrying values
may not be recoverable and at least annually. Factors we
consider important, which 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 materially
impact future results of operations and financial position in
the reporting period identified.
In accordance with SFAS 142, “Goodwill and Other
Intangible Assets,” we test goodwill and intangible assets
with indefinite lives for impairment on an annual basis as of
July 1, and between annual tests if indicators of potential
impairment exist. The impairment test compares the fair value of
the reporting unit to its carrying amount, including goodwill
and intangible assets with indefinite lives, to assess whether
impairment is present. We have reviewed the provisions of
SFAS 142 with respect to the criteria necessary to evaluate
the number of reporting units that exist. Based on our review,
we have determined that we operate in one reporting unit. Based
on this assessment, we have not had any impairment charges
during our history as a result of our impairment evaluation of
goodwill and other indefinite-lived intangible assets under
SFAS 142.
In accordance with SFAS 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets,” we
periodically review long-lived assets for impairment whenever
events or changes in business circumstances indicate that the
carrying amount of the assets may not be fully recoverable or
that the useful lives of those assets are no longer appropriate.
Each impairment test is based on a comparison of the
undiscounted cash flows to the recorded carrying value for the
asset. If impairment is indicated, the asset is written down to
its estimated fair value based on a
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discounted cash flow analysis. No impairment charges were taken
in fiscal 2006, 2005 or 2004, based on the review of long-lived
assets under SFAS 144.
Significant judgments and estimates are involved in determining
the useful lives of our long-lived assets, determining what
reporting units exist and assessing when events or circumstances
would require an interim impairment analysis of goodwill or
other long-lived assets to be performed. Changes in our
organization or our management reporting structure, as well as
other events and circumstances, including but not limited to
technological advances, increased competition and changing
economic or market conditions, could result in (a) shorter
estimated useful lives, (b) additional reporting units,
which may require alternative methods of estimating fair values
or greater disaggregation or aggregation in our analysis by
reporting unit,
and/or
(c) other changes in previous assumptions or estimates. In
turn, this could have a significant impact on our consolidated
financial statements through accelerated amortization
and/or
impairment charges.
Accounting for Acquisitions: We have completed
a number of significant business and other asset acquisitions
over the preceding five years which have resulted in significant
goodwill and other intangible asset balances. Our future
business strategy contemplates that we may continue to pursue
additional acquisitions in the future. Our accounting for
acquisitions involves significant judgments and estimates
primarily, but not limited to: the fair value of certain forms
of consideration, the fair value of acquired intangible assets,
which involve projections of future revenue and cash flows, the
fair value of other acquired assets and assumed liabilities,
including potential contingencies, and the useful lives and, as
applicable, the reporting unit, of the assets. Our financial
position or results of operations may be materially impacted by
changes in our initial assumptions and estimates relating to
prior or future acquisitions. Additionally, under SFAS 142,
we determine the fair value of the reporting unit, for purposes
of the first step in our annual goodwill impairment test, based
on our market value. If prior or future acquisitions are not
accretive to our results of operations as expected, our market
value declines dramatically, or we determine we have more than
one reporting unit, we may be required to complete the second
step which requires significant judgments and estimates and
which may result in material impairment charges in the period in
which they are determined.
Accounting for Long-Term Facility
Obligations: We have historically acquired
companies which have previously established restructuring
charges relating to lease exit costs, and we have recorded
restructuring charges of our own that include lease exit costs.
We follow the provisions of
EITF 95-3
“Recognition of Liabilities in Connection with a Purchase
Business Combination” or SFAS 146 “Accounting for
Costs Associated with Exit or Disposal Activities” as
applicable. In accounting for these obligations, we are required
to make assumptions relating to the time period over which the
facility will remain vacant, sublease terms, sublease rates and
discount rates. We base our estimates and assumptions on the
best information available at the time of the obligation having
arisen. These estimates are reviewed and revised as facts and
circumstances dictate; changes in these estimates could have a
material effect on the amount accrued on the balance sheet.
Accounting for Share-Based Payments: We
account for share-based payments in accordance with
SFAS 123(R), “Share-Based Payment.” Under the
fair value recognition provisions of this statement, share-based
compensation cost is measured at the grant date based on the
value of the award and is recognized as expense over the
requisite service period which is generally the vesting period.
Determining the fair value of share-based awards at the grant
date requires judgment, including estimating expected dividends,
share price volatility and the amount of share-based awards that
are expected to be forfeited. If actual results differ
significantly from these estimates, share-based compensation
expense and our results of operations could be materially
impacted.
Pension and Post-Retirement Benefit Plans: We
have defined benefit pension plans that were assumed as part of
the acquisition of Dictaphone Corporation on March 31,
2006, which provide certain retirement and death benefits for
former Dictaphone employees located in the United Kingdom and
Canada. The Company also assumed a post-retirement health care
and life insurance benefit plan, which is frozen relative to new
enrollment, and which provides certain post-retirement health
care and life insurance benefits, as well as a fixed subsidy for
qualified former employees in the United States and Canada. We
use several actuarial and other factors which attempt to
estimate the ultimate expense, liability and assets values
related to our pension and post-retirement benefit plans. These
factors include assumptions about discount rates, expected
return on plan assets and the rate of future compensation
increases. In addition, subjective assumptions, such as
withdrawal and mortality rates, are also
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utilized. The assumptions may differ materially from actual
results due to the changing market and economic condition or
other factors, and depending on their magnitude, could have a
significant impact on the amount we recorded. Pension and
post-retirement benefit plan assumptions are included in
Note 18 of Notes to the Consolidated Financial Statements.
Income Taxes: Deferred tax assets and
liabilities are determined based on differences between the
financial statement and tax bases of assets and liabilities
using enacted tax rates in effect in the years in which the
differences are expected to reverse. We do not provide for
U.S. income taxes on the undistributed earnings of its
foreign subsidiaries, which we considers to be indefinitely
reinvested outside of the U.S. in accordance with
Accounting Principles Board (APB) Opinion No. 23,
“Accounting for Income Taxes — Special
Areas.”
We make judgments regarding the realizability of our deferred
tax assets. In accordance with SFAS 109, “Accounting
for Income Taxes,” the carrying value of the net deferred
tax assets is based on the belief that it is more likely than
not that we will generate sufficient future taxable income to
realize these deferred tax assets after consideration of all
available evidence. We regularly review our deferred tax assets
for recoverability considering historical profitability,
projected future taxable income, and the expected timing of the
reversals of existing temporary differences and tax planning
strategies.
Valuation allowances have been established for
U.S. deferred tax assets, which we believe do not meet the
“more likely than not” criteria established by
SFAS 109. If we are subsequently able to utilize all or a
portion of the deferred tax assets for which a valuation
allowance has been established, then we may be required to
recognize these deferred tax assets through the reduction of the
valuation allowance which would result in a material benefit to
our results of operations in the period in which the benefit is
determined, excluding the recognition of the portion of the
valuation allowance which relates to net deferred tax assets
acquired in a business combination and created as a result of
share-based payments. The recognition of the portion of the
valuation allowance which relates to net deferred tax assets
resulting from share-based payments will be recorded as
additional
paid-in-capital;
the recognition of the portion of the valuation allowance which
relates to net deferred tax assets acquired in a business
combination will reduce goodwill, other intangible assets, and
to the extent remaining, the provision for income taxes.
Loss Contingencies: We are subject to legal
proceedings, lawsuits and other claims relating to labor,
service and other matters arising in the ordinary course of
business, as discussed in Note 17 of Notes to the
Consolidated Financial Statements. Quarterly, we review the
status of each significant matter and assess our potential
financial exposure. If the potential loss from any claim or
legal proceeding is considered probable and the amount can be
reasonably estimated, we accrue a liability for the estimated
loss. Significant judgment is required in both the determination
of probability and the determination as to whether an exposure
is reasonably estimable. Because of uncertainties related to
these matters, accruals are based only on the best information
available at the time. As additional information becomes
available, we reassess the potential liability related to our
pending claims and litigation and may revise our estimates. Such
revisions in the estimates of the potential liabilities could
have a material impact on our results of operations and
financial position.
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In September 2006, the FASB issued SFAS 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB
Statements 87, 88, 106, and 132(R)”
(“SFAS 158”). SFAS 158 requires an employer
to recognize the over-funded or under-funded status of a defined
benefit postretirement plan (other than a multiemployer plan) as
an asset or liability in its statement of financial position and
to recognize changes in that funded status in the year in which
the changes occur through comprehensive income. SFAS 158
also requires the measurement of defined benefit plan assets and
obligations as of the date of the employer’s fiscal
year-end statement of financial position (with limited
exceptions). Under SFAS 158, we will be required to
recognize the funded status of its defined benefit
postretirement plan and to provide the required disclosures
commencing as of September 30, 2007. The requirement to
measure plan assets and benefit obligations as of the date of
the employer’s fiscal year-end is effective for our fiscal
year ended September 30, 2009. We are currently evaluating
the impact that SFAS 158 will have on our consolidated
financial statements.
In September 2006, the United States Securities and Exchange
Commission issued SAB 108, “Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements.” This SAB provides
guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. SAB 108 establishes an
approach that requires quantification of financial statement
errors based on the effects of each of our financial statements
and the related financial statement disclosures. The SAB permits
existing public companies to record the cumulative effect of
initially applying this approach in the first year ending after
November 15, 2006 by recording the necessary correcting
adjustments to the carrying values of assets and liabilities as
of the beginning of that year with the offsetting adjustment
recorded to the opening balance of retained earnings.
Additionally, the use of the cumulative effect transition method
requires detailed disclosure of the nature and amount of each
individual error being corrected through the cumulative
adjustment and how and when it arose. We do not anticipate that
SAB 108 will have a material impact on our financial
statements.
In July 2006, the FASB issued Interpretation 48,
“Accounting for Uncertainty in Income Taxes — an
Interpretation of FASB Statement No. 109.” FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in a company’s financial statements in
accordance with SFAS 109, “Accounting for Income
Taxes.” FIN 48 prescribes the recognition and
measurement of a tax position taken or expected to be taken in a
tax return. It also provides guidance on derecognition,
classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for
our fiscal year beginning October 1, 2007. We are currently
evaluating the effect that the adoption of FIN 48 will have
on our consolidated financial statements.
In March 2006, the FASB issued EITF
06-03,
“How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That is, Gross versus Net Presentation)” that
clarifies how a company discloses its recording of taxes
collected that are imposed on revenue-producing activities. EITF
06-03 is
effective for the first interim reporting period beginning after
December 15, 2006, and thus we are required to adopt this
standard as of January 1, 2007, in the second quarter of
our fiscal year 2007. We are evaluating the impact, if any, that
EITF 06-03
may have on our consolidated financial statements.
In February 2006, the FASB issued SFAS 155,
“Accounting for Certain Hybrid Financial Instruments,”
which amends SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” and SFAS 140,
“Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities.” SFAS 155
simplifies the accounting for certain derivatives embedded in
other financial instruments by allowing them to be accounted for
as a whole if the holder elects to account for the whole
instrument on a fair value basis. SFAS 155 also clarifies
and amends certain other provisions of SFAS 133 and
SFAS 140. SFAS 155 is effective for all financial
instruments acquired, issued or subject to a remeasurement event
occurring in fiscal years beginning after September 15,
2006 and is therefore required to be adopted by us as of
October 1, 2006. We do not anticipate the adoption of
SFAS 155 will have any impact on our consolidated financial
statements.
In May 2005, the FASB issued SFAS 154, “Accounting
Changes and Error Corrections,” which replaces APB 20,
“Accounting Changes” and SFAS 3, “Reporting
Accounting Changes in Interim Financial Statements —
An Amendment of APB Opinion No. 28.” SFAS 154
provides guidance on the accounting for and reporting of
accounting changes and error corrections. It establishes
retrospective application, or the latest practicable date, as
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the required method for reporting a change in accounting
principle and the reporting of a correction of an error.
SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after
December 15, 2005 and is therefore required to be adopted
by us as of October 1, 2006. To the extent we make any
accounting changes or error correction in future periods the
adoption of SFAS 154 could have a material impact on our
consolidated financial statements.
We are exposed to market risk from changes in foreign currency
exchange rates and interest rates, which could affect operating
results, financial position and cash flows. We manage our
exposure to these market risks through our regular operating and
financing activities and, when appropriate, through the use of
derivative financial instruments.
We are exposed to changes in foreign currency exchange rates.
Any foreign currency transaction, defined as a transaction
denominated in a currency other than the U.S. dollar, will
be reported in U.S. dollars at the applicable exchange
rate. Assets and liabilities are translated into
U.S. dollars at exchange rates in effect at the balance
sheet date and income and expense items are translated at
average rates for the period. The primary foreign currency
denominated transactions include revenue and expenses and the
resulting accounts receivable and accounts payable balances
reflected on our balance sheet. Therefore, the change in the
value of the U.S. dollar as compared to foreign currencies
will have either a positive or negative effect on our financial
position and results of operations. Historically, our primary
exposure has related to transactions denominated in the Euro,
British Pound, Canadian Dollar, Japanese Yen, Israeli New
Shekel, and Hungarian Forint.
Assuming a 10% appreciation or depreciation in foreign currency
exchange rates from the quoted foreign currency exchange rates
at September 30, 2006, the impact to our revenue, operating
results or cash flows could be adversely affected.
In certain instances, we have entered into forward exchange
derivative contracts to hedge against foreign currency
fluctuations. In all cases, we use these derivative instruments
to reduce our foreign exchange risk by essentially creating
offsetting market exposures. The success of the hedging program
depends on our forecasts of transaction activity in the various
currencies. We do not use derivative instruments for trading or
speculative purposes. At September 30, 2006, there were no
outstanding derivative foreign exchange hedging instruments and
we did not enter into any forward exchange derivative contracts
during fiscal 2006.
On November 3, 2003, we entered into a forward exchange
derivative contract to hedge our foreign currency exposure
related to 3.5 million euros of inter-company receivables
from our Belgian subsidiary to the United States. The contract
had a one-year term that expired on November 1, 2004. On
November 1, 2004, we renewed this forward hedge contract;
the renewed contract had a one-year term expiring on
November 1, 2005; however it was cancelable at our
discretion. In February 2005, the Company liquidated the
contract. For fiscal year 2005 and 2004, the Company realized a
loss of $0.4 million, and recognized a gain of less than
$0.1 million, respectively, related to this hedge.
On November 5, 2003, we entered into a forward exchange
derivative contract to hedge our foreign currency exposure
related to 7.5 million Singapore Dollars of inter-company
receivables from our Singapore subsidiary to the United States.
The original contract expired on January 30, 2004, but was
extended to October 29, 2004. The contract was terminated
on October 29, 2004. We realized a loss of approximately
$0.2 million in connection with the termination of this
hedge.
We are exposed to interest rate risk as a result of our
significant cash and cash equivalents, and the outstanding debt
under the 2006 Credit Facility.
At September 30, 2006, we held approximately
$112.3 million of cash and cash equivalents primarily
consisting of cash and money-market funds. Due to the low
current market yields and the short-term nature of our
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investments, a hypothetical change in market rates is not
expected to have a material effect on the fair value of our
portfolio or results of operations.
At September 30, 2006, our total outstanding debt balance
exposed to variable interest rates was $353.2 million. To
partially offset this variable interest rate exposure, the
Company entered into a $100 million interest rate swap
derivative contract. The interest rate swap is structured to
offset period changes in the variable interest rate without
changing the characteristics of the underlying debt instrument.
A hypothetical change in market rates would have a significant
impact on the interest expense and amounts payable relating to
the $253.2 million of debt that is not offset by the
interest rate swap; assuming a 1.0% change in interest rates,
the interest expense would increase $2.5 million per annum.
Nuance
Communications, Inc. Consolidated Financial Statements
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NUANCE
COMMUNICATIONS, INC.
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Board of Directors and Stockholders
Nuance Communications, Inc.
Burlington, Massachusetts
We have audited the accompanying consolidated balance sheets of
Nuance Communications, Inc. (the “Company”) as of
September 30, 2006 and 2005, and the related consolidated
statements of operations, stockholders’ equity and
comprehensive income (loss), and cash flows for each of the two
years in the period ended September 30, 2006, and for the
nine-month period ended September 30, 2004. These financial
statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Nuance Communications, Inc. at September 30,
2006 and 2005, and the results of its operations and its cash
flows for each of the two years in the period ended
September 30, 2006, and for the nine-month period ended
September 30, 2004, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Nuance Communications, Inc.’s internal
control over financial reporting as of September 30, 2006,
based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report
dated December 14, 2006, expressed an unqualified opinion
thereon.
As described in note 16 of the Notes to Consolidated
Financial Statements, Nuance Communications, Inc. adopted
Statement of Financial Accounting Standards
No. 123(R), “Share-Based Payment,”
effective October 1, 2005.
/s/ BDO
SEIDMAN, LLP
BDO Seidman, LLP
Boston, Massachusetts
December 14, 2006
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Board of Directors and Stockholders
Nuance Communications, Inc.
Burlington, Massachusetts
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control over
Financial Reporting, that Nuance Communications, Inc. (the
“Company”) maintained effective internal control over
financial reporting as of September 30, 2006, based on the
criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on
Internal Control Over Financial Reporting, management’s
assessment of and conclusion on the effectiveness of internal
control over financial reporting did not include the internal
controls of Dictaphone Corporation, which the Company acquired
on March 31, 2006, and which is included in the 2006
consolidated financial statements of Nuance Communications, Inc.
from the date of the acquisition and constituted approximately
42.8% of consolidated assets as of September 30, 2006, and
approximately 20.1% of consolidated revenue for the year ended
September 30, 2006. Management did not assess the
effectiveness of internal controls over financial reporting of
Dictaphone Corporation because the Company acquired this entity
during its fiscal year ended September 30, 2006. Refer to
Note 3 to the consolidated financial statements for further
discussion of this acquisition and its impact on the
Company’s consolidated financial statements. Our audit of
internal control over financial reporting of Nuance
Communications, Inc. also did not include an evaluation of the
internal control over financial reporting of Dictaphone
Corporation.
In our opinion, management’s assessment that Nuance
Communications, Inc. maintained effective internal control over
financial reporting as of September 30, 2006, is fairly
stated, in all material respects, based on the criteria
established in Internal Control-Integrated Framework
issued by COSO. Also, in our opinion, Nuance Communications,
Inc. maintained, in all material respects, effective internal
control over financial reporting as of September 30, 2006,
based on the criteria established in Internal
Control-Integrated Framework issued by COSO.
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We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
2006 consolidated financial statements of Nuance Communications,
Inc. and our report dated December 14, 2006 expressed an
unqualified opinion thereon and indicated that the Company
adopted Statement of Financial Accounting Standards
No. 123(R), “Share-Based Payment,”
effective October 1, 2005.
/s/ BDO
SEIDMAN, LLP
BDO Seidman, LLP
Boston, Massachusetts
December 14, 2006
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NUANCE
COMMUNICATIONS, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
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NUANCE
COMMUNICATIONS, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
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NUANCE
COMMUNICATIONS, INC.
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