Nuance Communications, Inc.
Q1 2017 Earnings Call Transcript

Published: 8 Feb 2017

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to Nuance's First Quarter Fiscal 2017 Conference Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. As a reminder, this conference is being recorded. With us today from Nuance are Chairman and CEO, Paul Ricci; CFO, Dan Tempesta; EVP of Corporate Strategy and Development, Bruce Bowden; and Director of Investor Relations, Christine Marchuska. At this time, I would like to turn the call over to Ms. Marchuska. Please go ahead.

[Christine Marchuska:]

Thank you. 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 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, which are available on our website. Those remarks are intended to serve in place of extended formal comments and we will not repeat them here. I will now turn the call over to Paul.

[Paul A. Ricci:]

Good afternoon, everyone.

[Operator:]

Sorry, Mr. Ricci, we lost your sound all of a sudden.

[Paul A. Ricci:]

Can you hear me now?

[Operator:]

Yes, I can. Thank you.

[Paul A. Ricci:]

First, we delivered a strong first quarter with solid performance across our key financial metrics. Net new bookings for the quarter were up 23% compared to Q1 2016. We reported Q1 non-GAAP revenue of $496 million and EPS of $0.35, both metrics meeting the high end of our guidance range. Recurring revenue increased to 73%, up 600 basis points from a year ago. And cash flow from operations remained strong at 122% of non-GAAP net income. Second, we advanced the initiatives that we've articulated in recent quarters. In particular, we've made continued progress on our transformation program that is designed to strengthen our portfolio, improve operations, and enhance revenue growth. As part of these initiatives, we continue to advance our solutions portfolio with offerings that combine our core voice and language solutions with new capabilities for artificial intelligence and analytics. Examples include Dragon Medical Advisor, our enhanced Dragon Drive solution and our omni-channel Enterprise offerings, which also incorporate security and biometrics. In addition, we are expanding addressable opportunities with further investments in targeted geographies and vertical markets. This broader portfolio along with these other market investments has enhanced overall demand for our offerings, contributed to our robust net new bookings, and strengthened our pipeline. Looking ahead, our performance in Q1 has increased our confidence in our full year 2017 financial objectives. Over the balance of the year, we see the opportunity to overachieve in our Healthcare business and to overachieve as well in our Mobile business, especially based upon the contributions from our automotive and mobile operator business lines. We expect that our Enterprise business will achieve our full year expectations, and we anticipate the sum of all these trends will offset the underperformance in Imaging that will likely persist for a couple of quarters as our operational remediation takes hold there. For margins and earnings, we will continue our transformation program with focus on incremental cost savings, additional leverage in our data center infrastructure, and disciplined hiring. So in closing and as referenced in our prepared remarks, the combination of these initiatives and trends in bookings, revenue and costs lead to our outlook for Q2 and provide further confidence in our FY 2017 targets. And we will now take your questions.

[Operator:]

Thank you. We'll go first to Saket Kalia with Barclays. Go ahead, please.

[Saket Kalia:]

Hi, guys. Thanks for taking my questions here. First, maybe could start with you, Dan, can you just talk quantitatively or qualitatively, however you prefer, about Dragon Medical subscription bookings versus perpetual? And what the average duration on those subscription bookings has looked like?

[Daniel David Tempesta:]

Sure. Well, of course, historically, we used to really book only the Dragon Medical perpetual licensing. But that's since much reduced over the last three quarters. There will always be some customers, whether they're smaller customers or certain emerging geographies where we continue to book the perpetual licenses but that really is shifting. The last three quarters have seen that shift and most recently, I'd say the majority of our units booked have been in the cloud offering. That's either a cloud stand-alone offering or integrated with our HIM offering and those are usually five year in term.

[Saket Kalia:]

Got it. And just for my follow-up for you, Paul, just moving to the Mobile and consumer business, we've all got questions about Amazon Alexa and Google Home and I want to ask the question in a slightly different way. Do you find that these devices, especially given your comments about some strength in Mobile, do you find that these devices are driving more interest from other consumer electronics manufacturers to embed voice recognition, and how are they thinking about insourcing that versus outsourcing that, if that makes sense?

[Paul A. Ricci:]

Yes. The answer to your question is, yes, the interest in voice and language solutions in electronic devices has, as you know, been high for some time, but this last year has seen an increased interest and an increased level of design work going on for prospective devices that are going to be coming out over the next couple of years. Of course, an area of intense focus and interest for us has been the automotive vertical broadly and the recent attention to voice has only served to accelerate the investments that are going on within the automotive business. A second area of focus for us has been telecommunications and cable operators who are looking to deploy voice-related solutions, particularly around entertainment in the home. And then there are range of specific specialties within emerging IoT, which have also we've referenced in previous quarters that has an accelerated interest as well.

[Saket Kalia:]

Great. That's very helpful. Thanks, guys.

[Operator:]

Thank you. Our next question will come from Jeff Van Rhee with Craig-Hallum. Go ahead, please.

[Jeff Van Rhee:]

Great. A couple from me. Paul, on the net new number, obviously very good on the quarter and you highlighted the areas that are driving the growth are lagging. I'm curious in terms of variance compared to expectations, not looking for quantification but just any outliers in terms of the strength in bookings and weakness in bookings versus expectations?

[Paul A. Ricci:]

Well, Healthcare was quite robust in its bookings performance in the quarter and Enterprise was quite robust as well, but generally speaking, we had a fairly strong bookings quarter everywhere except for in Imaging.

[Jeff Van Rhee:]

And while you're on it, touch on Imaging, it sounds like you said there's some remediation things in the works there. Can you talk about the remediation effects and why you think that can fix the situation and kind of along those lines, how you think about that segment longer-term growth rate?

[Paul A. Ricci:]

We made a series of changes in our go-to-market approach in Imaging related to account coverage, compensation, sales structure at the beginning of the fiscal year, which taken together have created distraction and disruption in our bookings and revenue flow in that business. We're altering those and remediating those and unwinding some of them. But as you know, that has to be done thoughtfully and over time. What we don't believe is that we have a fundamental change in the demand in the business, but just in the way we're addressing the business, and we believe it will take a couple quarters to work through those.

[Jeff Van Rhee:]

Got it. And then on the Enterprise side, obviously the top line performance is just outstanding here. You touched on it briefly in terms of what's driving it. I'm curious to your thoughts on the sustainability, you know, we're up into this teens growth range and just kind of where we are in the sort of the market opportunity for that segment, its ability to sustain that growth?

[Paul A. Ricci:]

Well, as you point out, it has an ambitious plan for fiscal 2017. We're off to a good start in fiscal 2017. We will have to continue our momentum in bookings and our progress with channels and the deployment of our new products in order to achieve the full year plan, but that is our expectations as we sit here today.

[Jeff Van Rhee:]

Okay, and one last brief one, if I could. Health, you talked about in the out-year that it will return to growth on an annual basis. Slicing it a little more thinly, if you're willing, Dragon has been the big headwind in the early part of this year. Is it conceivable or even probable that Healthcare could return to growth in the second half of the fiscal year?

[Paul A. Ricci:]

Well, I think I want to stick with our original forecast. I did reference in my opening remarks that Healthcare is off to a very strong start and we do see the opportunity to overachieve. But I don't think I want to provide more forecasted granularity with respect to the growth rate in Healthcare in the second half quarters.

[Jeff Van Rhee:]

Fair enough. Thanks for taking my questions.

[Operator:]

Thank you. Our next question comes from Tavis McCourt with Raymond James. Go ahead, please.

[Tavis C. McCourt:]

Hey. Thanks for taking my questions. My first one is on the Mobile segment. I think for a couple of quarters now you've referenced you expect the device segment within there to get back to some level of stability. Would that suggest that Mobile overall should start growing organically since the service provider in auto, I suspect, are growing nicely or are there other pieces of that business that are still going to keep that declining even as we look into later this year and 2018? And then secondly, on the cash flow, Dan, I guess, trying to get a sense of the sustainability of being able to generate operating cash flow ahead of the adjusted net income. Obviously, you've done it quite nicely the last couple of years. It looks like a lot of that's been driven by really strong deferred revenues and reasonably good network and capital management. And then, I guess, any comments you have around sustainability of that trend as we look maybe beyond 2017 would be helpful. Thanks.

[Paul A. Ricci:]

Do you want to take the cash flow first?

[Daniel David Tempesta:]

Sure. So cash flow, you are correct. We had a really strong cash flow quarter, 122% of our non-GAAP net income. We guided at the beginning of the year 110%. I would encourage you to think of it that way. You're right. You can't keep up that trend for that long, given the size of our deferred revenue at this point. So, and Q1 has historically been a pretty strong quarter, because we do have some strong cash collections that come in from the fourth quarter in some large contracts. So longer term, I think a lower percentage, just the way to think of it.

[Paul A. Ricci:]

With respect to your first question, we said previously that the Mobile business incorporates our automotive business line which is the largest proportion of Mobile. Our mobile operator services and our devices business which is made up of primarily, but not exclusively of handsets, and as you referenced and we've noted previously, we see secular decline in the handset contributions and that weighed on the business in 2016 and continues to weigh on the business in 2017. It is the case that the overall proportion of that it becomes smaller as we go through this year. And so the growth factors in the other business lines begin to look more attractive. I don't want to provide growth estimates for Mobile in 2018 at this point.

[Tavis C. McCourt:]

Great. And then, Paul, is there any – moving over to Enterprise obviously very strong this quarter, and frankly looks like it's been strong last couple of quarters, there was a pretty big strategic event I would think this quarter in the Chapter 11 filing by Avaya. Do you expect that to have any positive or negative impact to your call center business within Enterprise? Thanks.

[Paul A. Ricci:]

Avaya has been a good partner of ours and continues to be a good partner of ours. I don't anticipate any effect from the bankruptcy in terms of our relationship with them.

[Operator:]

Was that all, Mr. McCourt?

[Tavis C. McCourt:]

Yeah. I'm good. Thanks.

[Operator:]

All right. Thank you. Then, we'll go next to Sanjit Singh with Morgan Stanley. Go ahead, please.

[Hamza Fodderwala:]

Hi. This is Hamza Fodderwala in for Sanjit Singh. Could you give a little bit more color on what's driving the consistent double-digit growth in the Enterprise? Who do you most often compete against and who are you taking share from in this market?

[Adam Bruce Bowden:]

Yeah. This is Bruce. The growth of the Enterprise business has been pretty broad based. We have a number of different businesses there. The traditional business is on-prem, basically inbound automated voice, and that's experienced a really nice resurgence both in terms of license revenues and also the surrounding professional service revenues. In addition to that, really good growth of our on-demand offering and including from the live chat piece that we've just recently added with our TouchCommerce acquisition. And then we have a number of offerings around Nina, which is our automated virtual assistant. The bookings for Nina have been good over the last couple of years and many of those deployments are coming online with large global companies and we're starting to see revenue pick up from there. So, it's really quite broad based. In terms of competition, frankly, our most frequent competitor is for the company that we're selling to to not go forward with a deployment of this kind, that they decide to hold off on this kind of innovation and wait for a little while. Frontal competitors are relatively diverse and nichey in this space.

[Hamza Fodderwala:]

And then just one follow-up question, if I may. Apologies if I missed this earlier, but what were the sources of sales disruption in the Imaging business and when should we start to see this rebound?

[Paul A. Ricci:]

Yes. What I mentioned a few minutes ago was that we made a number of changes in our approach to the Imaging market and that included changes in our sales compensation, changes in the structure of our sales organization, changes in account coverage, and all those taken together, while done with good intentions, have had a disruptive effect upon our bookings and revenue. And it will take a couple of quarters to work through the best – the remediation as we unwind some of those changes and make modifications necessary to get back to the fundamental demand of the business.

[Hamza Fodderwala:]

That's all from me. Thank you.

[Operator:]

Thank you. We have a question from Ian Strgar with UBS. Please go ahead.

[Ian Strgar:]

Hi, guys. Thanks for taking my question. So, first, the net new bookings came in really strong in the quarter, but you guys left the full year guidance for that metric unchanged. I know it's a metric that has been volatile quarter-to-quarter, but can you guys just kind of talk through the gives and takes there and just if some business was pulled forward into Q1 and that's why you're not revising it up?

[Paul A. Ricci:]

The reason we're not revising it is that we've consistently encouraged investors to look at net new bookings on an annual basis and to look at the change in net new bookings on an annual basis and we've done that because we have enough large scale deals that it's difficult to predict the timing of those deals. And so, you may recall that in the early part of last year, we seemed challenged to achieve our net new bookings target, but in fact we did achieve our net new bookings target on a full year basis. And this year, we're off to a terrific start, but we would need more time before we would want to change the target. And so, our encouragement remains for investors to stay focused on the guidance range we gave on a full year basis.

[Ian Strgar:]

Okay. Understood. And one more, if I may. You guys hit the high end of your annual guidance this quarter for total percentage of revenue that's recurring at 73%. Are you guys expecting that to kind of bounce around for the remainder of the quarter, or is it possible that you guys overachieve on that metric and that could lead to a growth outperformance in the back half of the year?

[Adam Bruce Bowden:]

Yeah. Good question. This is Bruce. Again, there I think we would encourage you to look at our maintained level of guidance at about 72%, 73% for the year. There can be some variability in this. There is timing of the part of our business that does remain heavier on the perpetual license side that happens over the course of the year. So, it will likely bounce around a little bit and average out. Our best view right now is that it'll average out at the level that we previously indicated.

[Ian Strgar:]

Okay. Thanks for the color, guys.

[Operator:]

Thank you. And our final question will come from Tom Roderick with Stifel. Go ahead, please.

[J. Parker Lane:]

Hi, it's actually Parker Lane in for Tom Roderick. Thanks for taking my question. I was just wondering if you could comment on the contribution that TouchCommerce had in the quarter on top line performance and bookings, and how the process of that integration of their solution and selling to your existing base has gone to date. Thanks.

[Adam Bruce Bowden:]

Sure. When we bought TouchCommerce, we indicated to you all that it was running at a revenue run rate of about $50 million a year and that we expected it to grow to around $70 million this year. And it's doing very well against that pace. So, it is a strong contributor to growth. We had also told you I think that it would, if you do the math on that, it's $20 million, which is an additional 1% on our organic growth rate, the way we calculate organic growth. We are tracking very well against that plan. In terms of how it's doing commercially on the ground, we do have nice wins for TouchCommerce. So, the fundamental value proposition of this idea that you can first try to steer a chat toward automated treatment, but then ultimately be able to default to an agent and resolve the call efficiently seems to have good traction in the marketplace.

[J. Parker Lane:]

All right. Thank you.

[Operator:]

Thank you. And please go ahead with any closing remarks.

[Paul A. Ricci:]

All right. Then, we thank you all for joining us this quarter, and we look forward to speaking to you again next quarter. Thank you.

[Operator:]

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and choosing AT&T Executive TeleConference. You may now disconnect.