Nuance Communications, Inc.
Q1 2019 Earnings Call Transcript

Published: 8 Feb 2019

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to Nuance’s First Quarter and Fiscal 2019 Conference Call. All lines have been placed on mute to prevent any background noise. After the prepared remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. With us today from Nuance are Chief Executive Officer, Mark Benjamin; Chief Financial Officer, Dan Tempesta and Senior Vice President, Corporate Marketing and Communications, Richard Mack. At this time, I would like to turn the call over to Mr. Mack. Please go ahead.

[Richard Mack:]

Great. Thank you. Before we begin, I want to remind everyone that our discussion this afternoon includes predictions, estimates, expectations and other forward-looking statements. These statements are subject to risk and uncertainty that can cause material differences in our results. Please refer to our recent SEC filings for a discussion of these risks. All references to income statement results are non-GAAP unless otherwise stated. And as noted in our press release, we issued prepared remarks in advance of this call, which are available on the IR portion of our website. Those remarks are intended to supplement our comments on this call today. Good afternoon, everyone. Please note that our discussion includes predictions, estimates, expectations, and other forward-looking statements. These statements are subject to risks and uncertainties that could cause material differences in our actual results. Please refer to our recent SEC filings for a discussion of these risks. For today’s call, Mark will cover our first quarter highlights and provide an update on our progress and direction. Dan will discuss our financials and guidance at greater length, and then we’ll open the call for questions. To begin, I’ll turn the call over to Mark.

[Mark Benjamin:]

Thanks, Rick. Good afternoon and thank you everyone for joining us to discuss our first quarter results. As you saw in our materials today, we got off to a great start this fiscal year, delivering a strong first quarter, marked by several key accomplishments. First, we again set out and delivered on what we said we would do, and we even outperformed on several fronts. Second, we made great progress in our growth areas, including Dragon Medical Cloud offerings, our international healthcare expansion, automotive and insecurity and biometrics. Third, we hit additional milestones for a more simplified and focused company. And finally, we delivered on our capital allocation programs with recent share buybacks and other -- and other planned debt pay down in March. Overall, I’m incredibly proud of the way our team performed, continuing its great momentum coming out of Q4 2018. Today we’re going to take a little longer than we normally would on these calls especially in the financial section. I recommend staying with us as there are a number of important details associated with the imaging sale and creating a new baseline for the business and our continuing operations. This is especially relevant in our discussion of guidance and favorable trends. As you saw in our press release and prepared remarks, we delivered strong results across our P&L. In particular, we delivered revenue margins in EPS above our expectations, driven by meaningful progress in our growth and cost initiatives. You also saw that we introduced several accounting updates regarding ASC 606 and discontinued operations from the imaging sale. So it’s important to note that notwithstanding these updates, we over delivered on our core financial metrics, and have detailed the numbers in our materials to avoid any confusion. In healthcare, we’re off to a great start, with strength in our cloud offerings, especially Dragon Medical One or DMO, one of the crown jewels of the company. Given the performance of this product in Q1, we have subsequently raised guidance for DMO for the full fiscal year. As a result, we also feel particularly good about the range we provided for the annual recurring revenue metric that we introduced the last quarter, which is a leading indicator for our cloud business. Our pipelines are healthy and this is exactly the type of high quality, recurring, sticky revenue that we want as it generates strong margins and cash flow. Our health cloud, our healthcare cloud offerings are one of the brightest opportunities for us. To that end, in Q1 at RSNA, the leading radiology event, we unveiled a new AI based cloud version of PowerScribe, a radiology platform that will be available later this year. Customer reception at the event and in sales conversations has been overwhelmingly positive and we look forward to bringing this to market. We also continued our momentum in both acute and ambulatory markets and celebrated a number of important customer deployments that include Johns Hopkins, University of Rochester, Concord Hospital and Vanderbilt University Medical Center. I would be remiss, if I didn’t point out the strength and the upward revised guidance for our Dragon Medical license line. Although we are aggressively transitioning our U.S. client base to our DMO cloud solution, last quarter we discussed how the international uptake of Dragon Medical would start with our on-premise products since these health care markets tend to be a bit behind the U.S. Most of the outperformance in our Dragon Medical license line came from Europe, as we began to seed the market. I believe, we’re setting the stage for a strong adoption cycle, which is why we revised up our estimates in this division. Turning to Enterprise. The team had another strong quarter with some notable large customer wins including, Kroger and the U.S. Postal Service, as well as strong performance from our channel partner community, which includes Cisco, Genesis and Avaya to name just a few. Market demand and pipeline for our AI powered Omnichannel customer engagement solutions and services, which span digital, voice and security and biometrics remains strong. In the quarter, we had numerous go-live deployments for digital messaging and shot across large financial services, government, telecommunications and retail brands including Albertson, Esurance [ph] and Telecentro. Our voice and security solutions also had significant deployments including at Allied Irish Bank, Charter, Deutsche Telekom, Lloyds and PayPal. We are very pleased with how our team over performed in Q1, yet reminds you, that it is only the first quarter and enterprise can be lumpy quarter-to-quarter. We feel great about the full year and are reaffirming our previous guidance for enterprise in 2019. As you’ll recall from my first earnings call with Nuance. I was quick to point out that I take achieving our financial obligations to our investors very seriously. I’d rather err [ph] on being conservative rather than too aggressive. We are working hard to build credibility with all of you, and we will let our achievements, the momentum of our business speak for itself. Turning to our automotive business. Our team had a solid quarter as we secured a number of new design wins including Audi, Daimler, Jaguar, Land Rover and Hyundai amongst others. You should think of these as new wins primarily as new lines or models within existing customers. Given our expansive customer footprint the energy and velocity behind this business was vast was perhaps best exhibited last month at CBS where we showcased innovations like gaze detection coupled with augmented reality emotion analysis and siren detection. This was the first time Nuance had a significant presence on the CES floor and the timing could not have been better. After more than 300 meetings with customers, partners, media, analysts and investors the Nuance Automotive team generated real industry excitement about where we're headed. I’m appreciative of how this business is executing their multi-year plan, and I’m excited for how the upcoming spin will be able to unlock value. Giving this management team the ability to a portion resources without competing with our other businesses for investment dollars will be a huge benefit to this business. On that topic, the separation is on track for later this fiscal year, and we are well underway in the process of hiring a CEO, assembling a board of directors, carving out the assets and IT and finalizing the cross licensing process. Furthermore, we’ve assembled a dedicated internal team that has been exclusively focused on this important work without distraction to our other businesses, and operations. And finally, imaging. In its last quarter with Nuance went out on a high note and a strong quarter. As you saw last week, we completed the imaging sale roughly two months ahead of schedule. We’ll be using approximately $300 million of the proceeds from the transaction valued at $400 million to pay down some of our higher cost outstanding debt. This obviously has a nice effect of lowering some of our interest expense and improving our debt ratios. I am proud of the way the imaging organization rose to the occasion to close out their last chapter at Nuance. I’m confident that this team will prosper, and I wish them the best for the future. Overall, it was a great quarter for Nuance and we’re just warming up. While we’re pleased with the recent results, we are even more excited about what lies ahead. We have a strong pipeline, new solutions, new markets, and new opportunities. So, looking at our Q1 performance, our work on capital allocation and the numerous tailwinds for the company I think we are set up nicely for the remainder of the year. As we discussed in recent quarters, the thoughtful, comprehensive portfolio reviews and cost programs that we’ve completed, will help define the future of the business. Reflected in the Q1 results, you saw that we have been able to accelerate some of our cost reduction programs and importantly, give us the ability to also accelerate certain investment plans we laid out without reducing margins. We are on track and I’m very pleased with our progress. In addition, the market gave us an opportunity to buyback quite a bit of stock. 4.9 million shares in the quarter and another 1.2 million in January at what we think are very attractive prices. In my mind, doing so demonstrates confidence in the business and that we’re on a right path. Between the stock buybacks, and the 300 million of debt we’ll be paying down shortly, you can see our disciplined approach to capital allocation is progressing nicely. With the positive dynamics in our business, and what we’ve done with capital allocation, I’m pleased to say, that for our continuing operations, we are raising our operating margin and EPS guidance and maintaining full year revenue guidance. As I said last quarter, there will be some variability from quarter-to-quarter and our path to achieving our financial goals may not be exactly linear, but we feel really good about our plans, and are executing in a way that makes me incredibly proud of the team. I’ll turn the call over to Dan to spend a few minutes on the financials.

[Dan Tempesta:]

Thanks, Mark and good afternoon. As Mark mentioned we had a very strong first quarter and overachieved our guidance metrics on both revenue and earnings per share, Before jumping into the results and guidance discussion. I want to spend a few moments on the reporting and presentation changes this quarter. First, as we discussed last quarter, effective October 1st 2018, we have adopted a new ASC 606 revenue recognition standard using the modified retrospective approach, and therefore we are presenting within our 10Q and prepared remarks documents, both ASC 606 and 605 actual results. Under this approach, we do not recast our historical financials for the provisions of ASC 606. Given this lack of comparability, as I highlighted at the beginning of the fiscal year, our primary approach to evaluating the business results and guidance in fiscal year 2019 will be on an ASC 605 basis. We will continue to provide ASC 606 guidance only for revenue and EPS and that will only be on an annual basis. The remainder of my results and guidance discussion today will be on an ASC 605 non-GAAP basis. Consistent with our recommendation last quarter, we encouraged sell-side analysts to submit 605 estimates for consensus purposes. Second, on February 1st, we closed the sale of the imaging business to Kofax. Therefore, we are presenting our Q1, 2019 results on a continuing and discontinued operations basis, and have restated the prior year financial results reflect this change. However, since we previously provided guidance on a combined basis, I will briefly highlight those combined results against our prior guidance. I will then transition the discussion to a continuing operations basis only and explain the key drivers of our results. In the quarter, we delivered non-GAAP revenue, combined and non-GAAP revenue of $516.3 million up 1% on both and as reported inorganic growth basis. This exceeded the high end of our revenue guidance range, driven by over performance in enterprise licensing, in On-Demand cloud offerings as well as strong imaging results. Dragon Medical and Automotive also had very strong quarters. We delivered non-GAAP diluted earnings per share of $0.34 also above the high end of our guidance range, due to the strong revenues, the favorable healthcare revenue mix, and disciplined expense management in the quarter. You will see the combined results compared to our previous guidance, in a table on page five of our prepared remarks document. Turning to continuing operations, our Q1, 2019 non-GAAP revenues totaled $465.7 million, up 2% versus last year on an organic basis led by strong performance in Dragon Medical Cloud, Automotive and Enterprise. This was offset in part by the expected declines in EHR implementation services, back-end transcription services, and the continued wind down of our devices and SRS businesses. Before discussing margin results for the continuing operations, I want to provide some color on the imaging segments historic -- historical margin profile, so that you can better appreciate how the removal of this business will impact our continuing operations margins. The imaging business has historically enjoyed gross margins higher than the company average, due to the revenue mix towards higher, margin licensing, and maintenance revenues. However, operating margins more recently were closely aligned to the company average due to the higher imaging operating expenses. In Q1 2019, non-GAAP gross margins from continuing operation was 62.5% up 360 basis points compared to prior year. We benefited from higher revenues and an improved revenue net mix, particularly in healthcare, where there was a shift from professional services revenue toward higher margin cloud in license revenue. Non-GAAP operating margin from continuing operations for Q1, 2019 was 28.5% up 460 basis points from a year ago. We achieved these results while absorbing $4 million of stranded costs. This strong performance was due to the gross margin dynamics previously noted as well as disciplined expense management. Since I have mentioned stranded costs as part of the imaging sale, let me spend a few minutes on that topic. Overall, we expect stranded costs will be approximately $12 million from the imaging sale date through the end of the fiscal year. These costs primarily relate to our G&A functions and will be reflected in the operating section of the income statement. The costs will be offset by approximately $6 million in fees, we expect to receive related to providing transition services to Kofax. These fees will be recorded within other income, which is below the operating section of the income statement. What that means is that the full value of the stranded costs will burden our operating margins without the offsetting benefit of the TSA fees. However, the fees received will be reflected within our net income, earnings per share and cash flows. I will come back to this topic when I discuss guidance for the full year. One last point on stranded costs. The majority of our stranded costs reside within G&A. However, there are some shared costs that reside in other operating areas such as sales and marketing. The reallocation of these non-G&A costs to the continuing operations has a small impact to our historic segment margins. Please see our prepared remarks document for a reconciliation of these modest changes. As Mark mentioned earlier, we remain committed to our capital allocation approach and we are seeing the positive impacts on our earnings. In the first quarter of fiscal 2019, we repurchased 4.9 million shares of common stock at an average price of $15.36 per share. From the beginning of the fiscal year through January 31, the company has pre purchased a total of 6.1 million share for an aggregate consideration of $91.3 million. This has a noticeable impact in our shares outstanding for the remainder of the year. As it relates to debt, with the close of the imaging sale, we have notified our bondholders of our intent to pay down all outstanding amounts of our five and three eighths bonds due in 2020, at par for $300 million. Payment is expected to be made early next month, and will reduce annual cash interest expense by approximately $16.1 million. I am also very pleased with our current net debt leverage ratio at 3.2 times as of December 31. On a pro forma basis, giving effect to the planned debt pay down, the company’s net debt leverage ratio would have been approximately 2.8 times representing significant progress in the last twelve months. Let’s now discuss the full year continuing operations guidance. As I mentioned earlier, this guidance will match our primary reporting approach to managing the business, which will be on an ASC 605 continuing operations basis. Furthermore, as I discuss each of the guidance measures, I will provide color on the impacts of excluding discontinued operations, the effects of stranded costs as well as any updates we are seeing in our continuing operations. We have also provided guidance tables in the prepared remarks document that clearly lay out a bridge for each of the impacts I’m about to discuss. Lastly, while we expect the automotive spin to occur in Q4, we will continue to include the automotive business within our full year guidance until that transaction occurs. To begin on guidance. We forecast full year non-GAAP revenue from continuing up operations to be between $1.847 billion and $1,889 billion. This reflects no change to each of the segment revenue guidance ranges from 2019, but simply eliminates the projected imaging revenues as a result of the sale. For healthcare, although we are maintaining our overall revenue range, we are updating the mix to reflect strength in our Dragon Medical Cloud and Dragon medical licenses sold internationally, offset by a corresponding reduction in EHR implementation services. This updated revenue guidance also gives us further confidence in our ARR range of $245 million to $255 million. These updates to our individual healthcare lines are detailed in our prepared remarks document. In Enterprise, although we had a very strong first quarter as Mark previously mentioned, we are maintaining our prior revenue guidance range for the year. Turning to margins, prior to the impact of discontinued operations, we expected gross margins to be approximately 63%. When accounting for the impact of discontinued operations and stranded costs, our gross margins declined by approximately 200 basis points, establishing the baseline for continuing operations gross margins of 61%. This reduction is primarily driven by the loss of imaging license and maintenance revenues I referenced earlier. However, due to the improved revenue mix in healthcare, and disciplined expense management, we are raising our continuing operations gross margin guidance by 100 basis points to 62%. Our Healthcare segment margins were previously guided to be approximately 34% similar to 2018 after adjusting for the improved revenue mix and margin benefit and somewhat offset by the modest impact to stranded costs. We are raising our healthcare segment margin guidance to a range of 34% to 36%. Our original 2019 operating margin guidance was in the range of 26% to 26.5%. When accounting for the impact of discontinued operations and stranded costs, our operating margin declines by approximately 75 basis points to 100 basis points, establishing the operating margin baseline for continuing operations of 25 and a quarter to twenty five and a half percent. However, this is entirely offset by the operational benefits in our gross margin, and our disciplined expense management. As a result, on a continuing operation basis, we are raising our operating margin guidance by 75 basis points to 100 basis points to a range of 26% to 26.5%. Our full year non-GAAP diluted earnings per share guidance was originally $1.19 to $.27. The effective disc-ops and stranded costs reduced diluted earnings per share by $0.17 to $0.19 cents establishing continuing operations EPS baseline of $1.02 to $1.06. However, we are raising earnings per share for continuing operations by $0.08 to $0.10 resulting from the operational improvements I laid out, plus the reduced net interest from the $300 million debt pay down, the expected transition service fees from Kofax and the expect -- and the effect of our share buyback activities. Combined, these factors drive our revised earnings per share guidance on a continuing operations basis up to a range of a $1.10 to $1.18. This guidance does not assume any further share repurchases or debt pay down outside of what has already been discussed. Our previous 2019 guidance for cash flows from operations was between $390 million and $435 million. After excluding the operating cash flows we lose from the imaging business, offset by the cash flow benefits we expect from the operating improvements and interest expense savings, we now expect cash flows from operations guidance to be in the range of $380 million to $425 million, resulting in a reduction to the range of just $10 million. We are also providing our updated cash balance expectations as of September 30th 2019 in the prepared remarks document, which includes the effect of the share repurchases through January 31, as well as the planned debt paid down. For Q2, 2019 we expect non-GAAP continuing operations revenue between $439 million and $453 million. And we expect non-GAAP diluted earnings per share to be between $0.24 and $0.27. In closing, let me echo Mark's comments about our progress in the past quarter. We are moving forward on many fronts, and our team is motivated and focused on our near and long-term goals. I'm pleased by our accomplishments and I look forward to updating everyone throughout the year. With that, let me turn the call over to the operator to begin the Q&A session. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Saket Kalia from Barclays. Please go ahead. Your line is open.

[Saket Kalia:]

Hi, guys. Thanks for taking my questions here. A lot to get through here, but maybe we’ll start with you first, Mark, and maybe a question on the Healthcare business. Nice to see that is business do well in the outlook and the outlook stay the same. I think we also saw within that a little bit of a shift away from lower margin services revenue toward some of the higher-margin Dragon Medical cloud. And so the question is, can you talk about what's maybe driving that? Whether that something that we are driving with changes in the sales force or is it something that maybe the market is really dictating?

[Mark Benjamin:]

Yes. So, thanks for the question Saket. Good to hear from you. So certainly the shift in revenue for the Healthcare business, it actually is quite favorable for us as we look at our cloud business and all the characteristics that come with that business. So, we’re pleased to have the ability to raise the full year there. Now the softness we’re seeing is really around our EHR implementation services. And there’s others really know shift in our selling of those services. It's really about the broader market and if there are any go lives largely around epic installations that we handle the implementation for. So, that business had an incredibly strong second quarter last year followed by a third quarter and you remember last year we're talking about that strength which we viewed as somewhat abnormal and we’ve kind of normalize the business this year and we’re seeing a little bit of softness. So, we thought it was prudent to really kind of curtail what we thought the business could do and get it more in line with historic levels. But it's a shift. It’s a revenue mix rather, Saket that we actually like the outcome of. These -- also these installation services they're not really connected to our Dragon Medical cloud offerings. These are real true EHR implementations that ultimately benefit us in relationships, but they're not critical to our business going forward.

[Saket Kalia:]

Yes, absolutely, I think shift makes a ton of sense for the business. Maybe my follow-up for you, Dan, I appreciate the accounting of the stranded costs and some of the below the line impact from transition services agreements. But perhaps thinking beyond fiscal 2019, maybe just near-term -- maybe first, how do you think about those transition services sort of lasting? And then even beyond that longer-term how do you think about those stranded costs inside of the overall Nuance if that makes sense?

[Dan Tempesta:]

Yet. It’s a very good question. Contractually, those services go out for some time, but I'd say, we should really think about them lasting anywhere from six to 12 months. So I think Kofax is motivated to move off those services as well. So it will -- some of it will go into the next fiscal year, but I think the majority will start to wind down. As far as stranded costs are concerned, listen we’re really focused on it. As the services wind down we need to move those costs out of the business. We need to really protect our operating margins. We’re very focused on that as we take down the costs. Not every cost will be – there’ll be other places where some of the cost come out as well, so, again really focused on that $12 million that you see in the P&L.

[Saket Kalia:]

Got it. Very helpful. I’ll get back in queue. Thanks very much.

[Operator:]

Your next question comes from the line of Daniel Ives from Wedbush Securities. Please go ahead. Your line is open.

[Daniel Ives:]

Yes. Thanks. So maybe you could talk about so far what you’ve seen on the auto spin-offs, I mean, talk about positives from CES. But may be just talk about some changes for Nuance and the spin that you’ve heard from customer, partners to start there?

[Mark Benjamin:]

Yes. Sure, Daniel, it’s Mark. CES really gave us a chance and me a chance to spend significant time with our customers and partners. Think of those as the -- all the name brand OEMs and manufacturers that we all know. And I had several discussions with them as well as the large suppliers. And I think it’s exciting that they view the business on the standalone as staying really focused on the way it goes to market as truly a white label offering that now will also benefit from greater focus and a management team that really has less competing priorities that don't necessarily relate to the auto industry. So, the management team for auto business is also well-positioned for the spin. We've also made very good progress around in the market for new CEO, preparing a new Board of Directors, all the necessary filings, as well as all the internal work here around carving out the business for a standup relative to IP, cross licensing agreements and other related matters. So, we’re in a very good position. We’re executing as scheduled on all facets of the spin. And the market, it’s really is -- my feeling after leaving CES after literally those hundreds of meetings I referenced was quite positive.

[Daniel Ives:]

Great. And then, just on Healthcare. Look, you’re in the ton of these conversations with customers. How are they – talk about the secular changes for Nuance and what’s really changed in the last three to six months especially as we think about some of the transitions going on in terms of moves to the cloud as well as digital automation across hospitals? Thanks.

[Mark Benjamin:]

Yes. I mean, I think the story continues. I mean, the Healthcare industry at the acute and ambulatory levels is under massive pressure. It begins with physician fatigue and burnout and the required administration levels of a clinician day versus seeing patients and really measured outcomes and impacts on error rates. Not to mention pressure on costs and reimbursements, because we know that reimbursements come down unless the actual care is captured accurately. So, there's still remains a ton of pressure in the system. Our solution really continues to improve that environment in meaningful ways across all of those aspects. So I would say, we continue to really enjoy a market-leading position. Our solutions now that have transition to the cloud with Dragon Medical One really provide the ability to lay in more AI into the solutions which ultimately give physicians back more time, improve quality of care, make the solution more valuable and it really gives us the ability to extend the services beyond what we’re just doing today. So I -- the CEOs of large hospital networks and IBMs and even at the mid end of the market, they’re looking for help and we are really positioned in a very good spot to be able to offer that.

[Daniel Ives:]

Thanks.

[Operator:]

Your next question comes from the line of Jeff Van Rhee from Craig-Hallum. Please go ahead. Your line is open.

[Jeff Van Rhee:]

Great. Thanks. Congrats on the quarter, guys. A lot of moving parts to be share, but just a couple of sort of deeper dive just particular on the Healthcare side; and you called out, Mark, the strength in EMEA [ph] international around Dragon in particular on the licensing sides. Can you just talk about the dynamics of that international experience and a lot of green field there. It sounds like from your comments is that’s the way the customers want to consume this on a prem basis. Do you envision this multiple years of licensing? And then at some point down in the future we start to get the cloud? Or just talk about the demand and the method of delivery there internationally if you would?

[Mark Benjamin:]

Yes. Sure, Jeff. Well, first of all, I mean, we’re incredibly excited about the international expansion. If you remember I spoke in the last call about really doubling our addressable market and this was one of the essential tools to do that. We’re in a few different countries today that are largely still license based, on-prem based and we are standing up our cloud solution and think of it as three or four different countries in Europe, in Australia and in North America, we’re essentially all cloud in the U.S. and Canada. So we’ll continue to go to market. We think strategically is important throughout Europe in key markets to sell our Dragon Medical solution as a license where the market is still only a license market. And ultimately as you know, we have a very good ability to flip them over to our cloud solution. And in some cases, Jeff, we’re still not deployed on a cloud enabled solution in some countries. The strength in the quarter came right out of Europe on that Dragon Medical license line and we see a very strong pipeline to continue. And our customers when they sign up with Nuance they stay for many years. So, we think we have a great opportunity for the long term to go in and with license, convert to cloud as the market and as our solutions are prepared.

[Jeff Van Rhee:]

And just to be clear, I mean, obviously you post good numbers there, but compared to your expectations coming into the quarter, EMEA in particular outperformed on Dragon?

[Mark Benjamin:]

Yes. It was a strong quarter for EMEA.

[Jeff Van Rhee:]

Okay. And then on the enterprise side can you just talk a bit about kind of the demand environment segmented kind of down the middle if you would. Omnichannel, digital channels on one side, and sort of legacy on the other, it sounds like you called out some on-prem licenses with some of your historical Cisco, Avaya type partners. Just talk about the two sides of the business both what you saw on the legacy side the quarter that drove the overages and then to spend to talk about what you're sitting on the omnichannel side as well?

[Mark Benjamin:]

Sure. We actually saw strength in the quarter really across all lines of or lines of business if you will with enterprise. We had a very good quarter with our voice and security solutions around biometrics. We continue to be the de facto standard and IVR in the industry. And again our digital omnichannel solutions really are resonating end-to-end in the market. So it’s really a third quarter in a row, so that this business is really performed quite nicely. And you know, we’re thrilled with the performance. We have great confidence in the full year for the business. And I'd say we’re doing well across the product suite there. The competition remains the same. We continue to do well relative to our competitors. Our channel partners continue to I think go-to-market with us very well. And we had a good quarter and some of the cloud and on-demand solutions and enterprise too. And Jeff as you know the business -- some of those solutions that are “on demand” have to do it outbound and perhaps even airline has weather impacting delays or schools closing or late openings, that tends to, if you will ring the register with our on-demand solution. So we had a very nice quarter. It's a great way to start the year for the business.

[Jeff Van Rhee:]

And just one last follow-up there; on the legacy, the strong the premise licensed performance. Just pipeline there. How does – what’s the outlook there? How does the pipeline look for similar strength?

[Mark Benjamin:]

You’re still talking about the -- I'm sorry, the enterprise business.

[Jeff Van Rhee:]

The enterprise premise licensed business.

[Mark Benjamin:]

Yes. It continues to be very good. When we build the full year plans we look at the pipeline. We look at what's in our backlogs. And we certainly got off to a strong start but the team feels very good about the year and what's in store. So we’d say positive.

[Jeff Van Rhee:]

Got it. Good. Thanks so much.

[Mark Benjamin:]

All right, Jeff. Thanks.

[Operator:]

Your next question comes from the line of Sanjit Singh from Morgan Stanley. Please go ahead. Your line is open.

[Sanjit Singh:]

Hi. And thanks for taking the questions and congrats the team on the progress thus far. I had a question on the automotive spin-off sort of and maybe, Dan, some initial thoughts on how we’re thinking about the assets allocation towards automotive in terms of – do we think about some of the debt moving on to the automotive business, any thoughts there?

[Dan Tempesta:]

Sure. We’ve talked about this. This is something we are currently looking into of course with our advisors. Probably as we get further into the year we’ll give you some information more on that. But I think for planning purposes there's definitely going to be some debt on the books of automotive. Early planning would suggest we think debt leverage neutral on a combined basis. So whatever our leverage is at Nuance, if you lever up auto to allow for that leverage neutral that’s the right way to think about it now. But as we make progress we’ll talk more about it.

[Sanjit Singh:]

I appreciate those initial thoughts. That’s very helpful. And then, maybe on the topic of margins, I think the margin performance this quarter was the best I’ve seen maybe in a couple of years in terms of the improvement. And I know you were very clear about some of the puts and takes going forward. But in terms of the benefit is the right way to interpret the margin benefit is just the fact that the services business and Healthcare was down? Or are there more sort of durable longer-lasting operational improvement that you’re guiding in the business?

[Dan Tempesta:]

It’s little bit of both. We certainly had a good mix quarter across the board. The Healthcare mix is improving as Mark talked about. Enterprise had a really good quarter and it came with a very positive mix, so that certainly contributed when we score some large licensing that comes with very good margins and that helped. And then, yes, across the board of course we have a savings program and expense management that's always under way. We made really good progress in expense management this quarter, faster than we were expecting. So that also contributed to the higher margins. But that’s now allowing us to accelerate our investments in the sort of the five or six growth areas that we talked about, so we’re going to get on with that even earlier than we expected.

[Mark Benjamin:]

Sanjit, this is Mark. I would just echo Dan’s comments, mean that, the revenue mix in healthcare is really a great outcome because the stronger DMO revenues, obviously that becomes permanent. So those revenues now in the books at higher margins and as far as the cost programs and expense management we’re able to really bridge the gaps if you will of obviously the reset business after disk [ph] ops to now really raise and get back to you know in some cases it’s an amazing outcome to really be able to get back to those operating margins that we plan for the year absent in our imaging business. So, I'd say that we’re making significant investments back into the business while managing expenses, running the business for the future with investments and really having good outcomes of revenue mix. So as Dan said, it’s a combination of all those things, but from my view it's a very good outcome and something I'm really proud of the team.

[Sanjit Singh:]

Thank you for the color there. And maybe one last one that I’ll squeeze in. In terms of ARR I think that is a very useful metric for us to think about in terms of the healthcare business. I think the additional method that will be helpful in terms of driving the long-term cash flow within Healthcare. Just to get a sense of the renew rates that we’re seeing on that ARR. Is there any way to characterize what you’re seeing? I mean, should we think of that as mid-80s, 90% plus, anyway to get a sense of how the probability of those in recurring of revenues being renewed every year?

[Dan Tempesta:]

Yes, great question, Sanjit. This is Dan. So, we recall that we really just started the DMO journey, the Dragon cloud journey in 2016. So we haven’t really hit any meaningful renewal cycles yet. That’s coming probably in the next year or two. But if the Dragon Medical maintenance and support is any indication then we’re expecting very very high renewal rates. So -- and the early signs are suggesting that is true.

[Mark Benjamin:]

Yes. And that’s exactly right. And I also, I don't think we’ll be susceptible to a large renewal cycle, just given the growth rate of the business that taking place. So, even as the business gets bigger on Dragon cloud you see the 50% growth rates in the business. So these new sales if you will, new customers, new conversions of the base from our on-prem as well as the HIM conversions, those get layered in a multiple year agreements that renew at different times. So, we would expect a very high retention rate as a percentage of revenues when we begin to start to see renewals, I'd say as Dan mentioned.

[Sanjit Singh:]

Excellent. Thank you for the answers.

[Operator:]

Your next question comes from the line of Shaul Eyal from Oppenheimer. Please go ahead. Your line is open.

[Shaul Eyal:]

Thank you. Good afternoon, gentlemen. Congrats on results and the ongoing consistent execution. Mark, I want to go back to the International Healthcare expansion, the way we see it, this is a great development. I know you've been talking about it in the prior quarter. I think we're beginning to see that unfolding. I know it’s a tricky one, and I know you just beginning to work on that opportunity, but how should we think about the TAM, the opportunity, the disaddressable market opportunity that you might be seeing out there. Longer term could that be equal to what we have seen over the course of the past two decades within the U.S. I think we all have that numbers on that front. And also is it an upgrade opportunity. Is it a displacement opportunity. What have the European users been utilizing us so far? Thank you for that.

[Mark Benjamin:]

Sure. So, thanks Shaul for the question. And yes, we do see this as essentially a doubling of the addressable market as far as relative number of physicians to sell our services too. So think of that as we’ve use in the past 925,000 physicians in North America think of that as essentially a similar number to throughout Europe and some of our international markets beyond Europe. So, we are as excited as you and we think there is great opportunity. There is technology in the markets there, but less around broad adoption of the EHRs which is really where we get embedded into the solution and we become super critical to the workflow. So, I'd say the value proposition today in the market is just beginning because it will move truly just from light transcription and voice technology to rated, embedded workflow technology as the EHRs become mainstream. And we’re seeing the beginning signs of that. You know, we have a business that’s doing well in the UK. We’re seeding a few other countries in Europe as well as Australia. So, we think that this is the very early innings of that adoption cycle for us. Now, the payer systems are quite different country-by-country and region-by-region, but the fact is the value proposition to the physician and all the clinicians is really the same, and that the cost burden, the fatigue burden, the administrative burden and quality aspects of what we provide is really the value proposition going forward.

[Shaul Eyal:]

Got it, and understood, and thank you for that elaboration. Dan, thank your for the discussion on the debt front and I think that articulates to the net debt analysis. I think as you’ve mentioned we are around, let’s say, the sweet time give or take. Even hypothetically or maybe strategically would you be willing down the road to go back higher if needed, if there is a strategic opportunity whether on the healthcare front, whether on the enterprise front, will it be something you might be considering down the road? Or the level that you vindicated are pretty much the ones that you're seeing as the optimal ones in the near to mid future?

[Dan Tempesta:]

Hi, Shaul, yes, that’s a good question. You know, the great news about our financials is that we generate a tremendous amount of cash flow and that just gives us the availability for options like that if we wanted. We been focused on taking the debt down. When we were up at four times gross leverage and even more that was a fine level for us to be at. It’s a comfortable level. So if there was something that was really strategic and really important to do we could certainly go back there. But right now we’re focused on this current capital allocation approach and it's going well for us.

[Mark Benjamin:]

Yes. Shaul, this is Mark. So, I think Dan answered it perfectly. And like you'd expect the CFO to answer it. But I would say, he's absolutely right as our net leverage comes down into the high 2s and our portfolio review is completed and as we really emerge out of these programs we would likely be back in the market looking for the right type of opportunities for our business. And its -- we deemphasize that for the last call near 12 months and I don't want to suggest, we’re going to get back to our routine here that was once practice. But we will also be -- very good stewards of our capital, and that’s what you see is practicing today and we’ll same measuring stick if you will as we look to deploy capital and M&A environment too.

[Shaul Eyal:]

Got it. This is great feedback and thanks for that. And maybe just really if I may squeeze in. I believe I know the answer, but I want to hear it coming out of you guys and I think results without indicated, but any impact from the government shutdown, anything that you might have been seeing in recent weeks or recent months?

[Mark Benjamin:]

Shaul, we haven’t. I stay in very close contact with the sales leaders and so, I would hear of it because of course they’re always negotiating their quotas with me. And I haven’t heard any feedback relative to the shutdown and the impacts?

[Shaul Eyal:]

Got it. Super. Thank you so much. Good luck.

[Mark Benjamin:]

All right, Shaul. Thank you.

[Operator:]

[Operator Instructions] Your next question comes from the line of Tom Roderick from Stifel. Please go ahead. Your line is open.

[Tom Roderick:]

Hi, gentlemen, thanks for taking my questions. So, I wanted to kind of hit the enterprise segment here and think about it in two ways. Number one, just in terms of some of the innovation efforts you’re making and in particular I love to hear little bit more about customer response to voice biometrics. What that might be going from a vertical perspective and a demand perspective on the enterprise side. And then if I switch gears, the second part of that equation is, thinking about where while you’re innovating where there is an opportunity to create some efficiencies in the model on the enterprise side and think about how to expand those margin. So, if I look the first quarter, it looks like a 32% segment margin up I think from where last year was, but still sort of guiding the full year to about that 29% level if I’ve got it right on a 605 basis. So, maybe if you can help me just sort of think through what the demand level for new innovation looks like where you want to continue to innovate and how we think about the segment margin structure for this year and where that dollars goes back into? Thanks.

[Dan Tempesta:]

Sure. So, hey, thanks for the question. Yes, I mean the demand in pipeline through our enterprise is really focused around the AI solutions relative to customer engagement. I mean that really is I think the headline, the right way to think about this business. When we say omnichannel we’re talking about how expand the digital voice, spectrum of modality if you will like the different user interface is. Certainly voice security and voice biometrics is a very important part of those discussions, because the way we’re embedding our voice bio solutions, Tom is really in a – it can also be very much in a passive way within the call center of our customer, so that just one example of AI really being laid into the solution. I would also say that virtual assistants within the call centers, while that's not a new business for us. You've heard is probably talked about Nina in the past and well before my arrival. We’re starting to see I'd say you know a renewed momentum around virtual assistance in customer engagement, the capabilities and what we harvest around the technology is really emerging. In fact, we have our user conference taking place this week in Las Vegas where we’ve rolled out a new solution we call Pathfinder. And you may see that actually in the press this week as it got remarkable coverage and it's really relative to highly specialized domains around virtual assistance that we bring the market and that we’re now able to take voice conversational, voice interactions to make virtual assistants smarter with our Pathfinder solution. So by the ways this is one example of like the – I’d say the thirst that our customers have in the end of the market we play for technology all based on AI solutions, conversational AI solution. So we're seeing it yet throughout the Telcos. We’re seeing it throughout financial situations. We’re seeing in large retail environments where customer authentication and engagement is critical. And I think I also got a little lucky timing wise we’re joining Nuance really just as I think voice started to really take off in a new and meaningful way to Nuance certainly in enterprise and healthcare.

[Tom Roderick:]

And then maybe just a quick follow-up on that, I’ll focus all of it on you Dan, just in term of the profit segment for enterprise. It bounced around profitability last year little bit. Can you just remind us if anything seasonal from either a cost perspective or revenue recognition perspective that would cause that segment margin to jump around as we think about our own models?

[Dan Tempesta:]

Sure. It is always going to jump around. It is not going to be -- it's going to see that type of pattern. And its because in quarters we have really strong licensing, the margins go up and then when it's more an average level it will kind of level back down. So that sort of upper 20s is the right landing point for on a 12 month period, but it could have fluctuations in period to period. And I think as getting back to your question around how do you improve the margins. I think that as our digital channel cloud in some of our on-demand offerings get more mature and you see more activity running through those models. Over time we would really like to see our cloud margins go up and that should move the average up as well.

[Tom Roderick:]

Excellent. Really helpful. Thank you, guys.

[Dan Tempesta:]

Thank you.

[Operator:]

And there are no further questions at this time. I will now turn the call back to Mark Benjamin for closing remarks.

[Mark Benjamin:]

Hi. Well, I just want to thank everyone for joining us this evening. And make sure if you're down in Orlando at HIM’s next week to give us a look and we welcome you to show you our solution. So, thanks very much and have a nice night.

[Operator:]

That concludes our call this evening. You may now disconnect your lines.