Nuance Communications, Inc.
Q1 2018 Earnings Call Transcript

Published: 9 Feb 2018

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to Nuance's First Quarter Fiscal 2018 Conference Call. As a reminder, today's conference is being recorded. With us today from Nuance are Chairman and CEO, Paul Ricci; CFO, Dan Tempesta; and Vice President of 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:]

Thank you, Ryan. Before we begin, I remind everyone our discussion this afternoon 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. All references today to income statement results are non-GAAP unless otherwise stated. And as noted in our press release, we issued a set of prepared remarks in advance of this call. Those are available on our website. Those remarks are intended to serve in place of extended formal comments and will not be repeated here. I'll now turn the call over to Paul.

[Paul A. Ricci:]

Thank you, Rick, and good afternoon everyone. Before taking your questions, I'd like to highlight a few key points regarding our Q1 results and share my thoughts on the remainder of the year. In the first quarter, our company reached the important milestone of returning to organic growth. Three years ago, we undertook a plan to transform our business. We implemented actions to focus on new growth initiatives, develop integrated solutions and extend our geographic footprint, while implementing a productivity agenda to expand and protect margins. While our work is not complete, I'm pleased to say our Q1 results reflect the achievement of our persistent focus and execution against this transformation plan. We delivered strong performance across our key metrics, notably in revenue, EPS and net new bookings. Net new bookings were up 10% from the first quarter of fiscal year 2017. This growth was led by solutions tied to our vertical market focus, including Dragon Drive in Automotive, Dragon Medical cloud in Healthcare and our omni-channel and security solutions in financial services and telecommunications. In support of our vertical market focus, we've taken steps to realign our organization. Most notably, we've made progress in structuring the Automotive business as a separate operating unit and combining our mobile operator services business with the Enterprise division to have a more unified focus on the telecommunications market. As we look ahead, we approach the future with a strategy that is delivering results. And this confidence is reflected in our Q2 and full year fiscal 2018 guidance. We're raising our FY 2018 revenue and EPS guidance, driven primarily by our Healthcare, Enterprise and Automotive units. We've also raised our guidance for organic revenue growth to a range of 3% to 5%, up from 2% to 4% previously. The midpoint of this new range represents a 700 basis point improvement from our organic growth rate in fiscal 2017. Looking ahead, we remain focused on key vertical markets with conversational AI and analytics-powered solutions. We're accelerating investments in support of this focus funded by the continuation of our multi-year productivity initiatives, which we discussed in some detail last quarter. I'm confident that our pursuit of these select markets, leveraging a common technology stack, will continue to produce attractive gains in revenue growth, operating margins and EPS as we look towards fiscal 2019. Before closing, I want to comment briefly on succession. Nuance's board, through its search committee, has progressed its work and has noted in recent communications, expects to meet its goal of a final selection in time for the March 31 transition. And we're now happy to take your questions.

[Operator:]

Our first question will come from the line of Saket Kalia with Barclays. Please go ahead.

[Saket Kalia:]

Hi, guys. Thanks for taking my questions here. First, maybe for you, Paul. Helpful commentary on the Healthcare segment, but can we just go a little bit deeper in terms of the performance versus your expectations? It feels like you've been able to do very well in that segment versus your expectations post the malware attack. So could you just maybe touch on how much of this is coming from perhaps better underlying performance in places like Dragon Medical versus perhaps lower churn than you expected post-attack?

[Paul A. Ricci:]

I think there's some contribution from both of those. But notably, I would say that the Dragon Medical performance is clearly off to a very strong start for the year. I also would remind you that bookings coming out of the fourth quarter of last year were strong in Healthcare and in fact stronger than we had anticipated.

[Saket Kalia:]

Got it. Got it. And then for my follow-up, maybe for you, Dan. Can you just talk a little bit about the slightly lower margin guide here for fiscal 2018? Are we perhaps seeing a different mix in the business than we originally expected or is this related to maybe some of the remediation costs associated with the malware attack?

[Daniel David Tempesta:]

The guide is really adjusted for the mix that we're seeing. We're seeing more demand in our lower professional services margin type business, particularly in Healthcare. As it relates the malware attack, those costs really were baked in at the beginning of the year. They were reflected in the original margins and those are already in there. So, it's really a mix shift that we're seeing at this point.

[Paul A. Ricci:]

I think we would also just note that we've had to staff in support of the professional services growth in our Automotive business, our Enterprise business and our Healthcare business. And that's partly reflected in the margins.

[Saket Kalia:]

Understood. Thanks very much, guys.

[Operator:]

All right. Our next question comes from the line of Jeff Van Rhee with Craig-Hallum. Please go ahead.

[Jeff Van Rhee:]

Whoops. I had you on mute there. Just a couple for me. Just to follow up on the last question a bit with respect to the Healthcare, I think you commented that it's a mix driving down overall operating margins. Just looking specifically at Healthcare itself as a segment, how do you view operating margins for this segment? What's the outlook in that respect?

[Paul A. Ricci:]

Well, I don't want to make predictions for particular segment margins. We don't do that. But overall, we've given guidance that we expect to see year-over-year modest operating margin improvement, as we balance between protecting our margins and enabling the investments to fuel growth, which as you can see is beginning to have material results.

[Jeff Van Rhee:]

Okay. With respect to Enterprise, I think you commented in the script 21% growth in net new. Obviously, there are other variables that come into play for the overall top line. But as you look at that segment, is it safe to say we can look for acceleration of top line from Enterprise from current levels?

[Paul A. Ricci:]

Well, we've had really good top line growth in Enterprise over a number of quarters now. And we're going to continue to see top line performance there. I don't want to make predictions about particular quarters. We've always cautioned about that. And we've mentioned last quarter when we began the year. We mentioned the year-over-year comparables for Enterprise are going to become more difficult. So, we may not see the kind of growth we saw sustained over the last six or seven quarters, but it's going to continue to be a growth business.

[Jeff Van Rhee:]

Okay. And then certainly rumors in the market with respect to an Auto sale. I won't ask you to confirm it, but can you talk to sort of your thoughts on Auto? One, the growth I think you had commented was double-digit prior. I think you, in the script, say it's lower than that this quarter. Maybe just a little color about that deceleration, if you're still comfortable with double-digits. And then at a high level to the extent you can, just the logic of slicing this off as its own division and any other commentary with respect to whether or not that optimization of that value you may perhaps be as a separate entity or owned by someone else as opposed to within your business?

[Paul A. Ricci:]

Okay. Let me take them in turn, if I might. First, with respect to growth, we anticipate that being a double-digit growth business this year, of course, that's an annual growth rate and we don't have much to say about quarter-to-quarter. One has to look at the comparables in the previous quarter and flows in any particular quarter, but it's a business with high recurring revenues and we expect it to grow in double-digits this year. Your second question is why form it into a separate unit. We did talk about this some last quarter but just to recap that. It's a very dynamic business and it requires its own independent focus, the ability to operate at the speed in which the automotive technology markets are moving now, very rapidly moving markets. And we believe we were more likely to achieve that in a separate focused business. With respect to all the rumors, I really can't comment on that, of course.

[Jeff Van Rhee:]

Okay. All right. Thank you. Thanks, Paul.

[Operator:]

Next question comes from the line of Sanjit Singh with Morgan Stanley. Please go ahead.

[Sanjit K. Singh:]

Thank you for taking my questions. Paul, I wanted to dive into some of the cash flow dynamics that we expect in this coming year, particularly with respect to two things. One on DSOs, that's continuing to pick up. Obviously that's being impacted by Healthcare collections. And I was wondering if you had a view on when those collections could start to improve. And then secondly, also related to cash flow in the Automotive business in terms of slower deferred revenue growth, is that a function of cars being shipped and therefore triggering a revenue event and when could we start to see that deferred revenue growth in Auto start to stabilize?

[Daniel David Tempesta:]

Hey, Sanjit. It's Dan. First, the DSO, yes, we're still feeling the effects of the malware. We saw that in Q1. I would say that DSO is going to taper down throughout the remainder of the year. So you should think about that over the next couple of quarters coming back to low 70s. And that's really – we generally run high 60s, low 70s, so that will get back to normal. As it relates to the deferred revenue, we have been talking about this for some time. The Auto business in the connected side when the car ships we get paid. And for some period of time, we've been generating billings in advance of the revenue amortization. And now that's caught up, because over the years we've been collecting that cash and then the amortization is now kicking in at a similar level, not exactly, but at a similar level to the billing. So there's still some growth this year. It's modest in the auto space. And then over time, that will flatten out into 2019. And then it could slightly decrease in the future or it could stay flat or increase if we have more billings. But that is the pattern and that's why we guide flat to 3% growth this year.

[Sanjit K. Singh:]

Great. And then in terms of some of the efficiency programs that you guys have laid out, in terms of where we might see some of the benefits of those operational efficiencies that you guys are working on. It doesn't look like that's going to be a fiscal year 2018 event, but is that something that could be layered in into fiscal year 2019 or should we think about these efficiencies enabling you to further invest back into the business?

[Paul A. Ricci:]

Yeah. Of course, we've given guidance today in operating margins for 2018 and we've reaffirmed our previous indication that we expect perhaps 50 basis points of margin improvement in 2019. The foundation of that is, as perhaps as your question suggested, a balance between taking the productivity gains and reinvesting some of that into new products, expanded sales capacity, clearly meeting the services demand that we spoke about earlier and at the same time allowing some modest expansion of operating margins. So we're trying to balance the opportunity to seize additional growth with modest margin expansion.

[Sanjit K. Singh:]

Got it. Thank you very much.

[Operator:]

Next question comes from the line of Tom Roderick with Stifel. Please go ahead.

[Thomas Michael Roderick:]

Hi, gentlemen. Thanks for taking my questions. Paul, speaking to the growth on the Auto segment, I'm wondering if you can provide a little bit more detail in terms of what the advanced drivers of that business are today. It seems like you had a number of big design wins over the past several years, some new logo wins that certainly helped. But how much of that growth when we look at what you're reporting now comes from unit volume from pre-existing wins as opposed to new design wins themselves?

[Paul A. Ricci:]

I don't have a precise number for you, but I can tell you what the elements of growth are. One is additional design wins. There is a lot of activity in this space. Remember of course that design wins we're doing today are contributing mostly to bookings today, not to revenue, because those design wins are now out of the perimeter of 2020 models and 2021 models. The second is, but we have been of course winning successive new design wins over the last few years and those design wins or the contributions for those design wins are kicking in now. The second is expanded penetration within the designs we've had. Speech is being deployed more broadly. Our solutions are being deployed more broadly within the manufacturers we're working with. And then the third is the expansion of the functionality of the solutions, notably to include hybrid solutions that have both an in-car and a cloud-based element.

[Thomas Michael Roderick:]

Perfect. That's very helpful. Thank you. Follow-up question on Auto. I guess this is more broadly speaking for the whole Mobile segment. But it was noted in the script there that the profit margin decreased here a little over 800 basis points year-on-year, largely as a result of lower professional services gross margins. So can you speak to what's driving those lower services gross margins themselves? Is that a reflection of some of the work that's being done? Is it a reflection of a mix shift away from different segments? Can you talk to that and then how we ought to think about that going forward?

[Paul A. Ricci:]

There were two elements of contribution to the lower segment margins in Mobile. One was new investments and those investments are both in R&D and in marketing and particularly related to Automotive. We're doing that in order to advance the speed of our solutions and to seize the opportunities we've talked about there. The second is professional services staffing, which I commented on earlier and the need to serve greater demand for initial trials that we're doing with new vendors, as well as the demand for backlog we have in that business.

[Thomas Michael Roderick:]

Excellent. So, the productivity presumably will go up in coming quarters as those start to come online, it sounds like.

[Paul A. Ricci:]

Yes. We'll see efficiency. We'll see gains from additional staffing. But professional services margins in Automotive have been very high and the sustainable margin in that business – professional services margin may be somewhat lower.

[Thomas Michael Roderick:]

Got it. Very helpful. Thank you.

[Operator:]

And the final question we have in queue comes from the line of David Hynes with Canaccord. Please go ahead.

[David E. Hynes, Jr.:]

Hey. Thanks, guys. Just one from me, I'll keep it high level. Paul, if I consider your three core franchises; healthcare, auto, contact center, in which do you think you have the best competitive moat and in which do you most worry about competitive threats?

[Paul A. Ricci:]

Sorry. I did not hear the first half of your question. Could you say it again?

[David E. Hynes, Jr.:]

Yeah. Just three core franchises, healthcare, auto, contact center, in which of those do you have the best competitive moat? In which do you worry about competitive threats the most?

[Paul A. Ricci:]

We have competition in all of our businesses. But I think you've identified three core franchises that we think are differentiated through a combination of our vertical focus, the strength of our go-to-market presence and the differentiation of our technology stack. And I have great deal of confidence in the durability of our business in all three of those markets.

[David E. Hynes, Jr.:]

Okay. Yeah. I'll leave it there.

[Operator:]

Okay. We have no further questions in queue.

[Paul A. Ricci:]

Okay, then. I want to thank you all for taking the time with us today. Take care.

[Operator:]

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation, and for using AT&T Executive Teleconference. You may now disconnect.