Nuance Communications, Inc.
Q3 2015 Earnings Call Transcript

Published: 6 Aug 2015

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to Nuance's Third Quarter Fiscal 2015 Conference Call. At this time, all participants are in a listen-only mode. Later, there will be an opportunity for questions. As a reminder, this conference is being recorded. With us today are the Chairman and Chief Executive Officer of Nuance, Mr. Paul Ricci; CFO, Mr. Dan Tempesta; EVP of Corporate Strategy and Development, Mr. Bruce Bowden; and Vice President of Investor Relations, Mr. Kevin Faulkner. At this time, I would like to turn the call over to Mr. Faulkner. Please go ahead, sir.

[Kevin Faulkner:]

Thank you. Before we begin, I remind everyone that matters we discuss this afternoon include predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to our recent SEC filings for a detailed list of risk factors. All references to income statement results are non-GAAP unless otherwise stated. As noted in our press release, we also 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. Now, let me turn the call over to Paul Ricci.

[Paul A. Ricci:]

Good afternoon. Before taking your questions, I'd like to highlight several key points from today's earnings announcement. First, we've delivered sustained improvement in our financial performance including four consecutive quarters of year-over-year improvement in operating cash flow, non-GAAP operating margin and non-GAAP EPS. Compared to last year, operating cash flow grew 24%, non-GAAP operating margin improved by 290 basis points and non-GAAP EPS improved by $0.05. In addition, for 11 consecutive quarters, we have delivered at least 24% year-over-year growth in deferred revenue. Second, in Q2, we initiated a formal program to focus our product investments, increase our operating efficiencies, improve our gross margins, direct more resources to our best growth opportunities and further enhance shareholder value through ongoing share buybacks. Our transformation program is already delivering measureable benefits that can be seen in our financial results. In Q3 2015, non-GAAP gross margin increased year-over-year in every revenue category, and more broadly, we showed improved performance up and down the income statement. To date we have taken actions, which we expect to result in $50 million in annualized savings, significant progress towards our goal. We expect this program to deliver $125 million in annualized expense reductions by the fourth quarter of fiscal 2016. Additionally, and as you know, over the last several years we have experienced a significant shift in our business model toward recurring revenues. We've been driving this shift in order to deliver the technological benefits of cloud computing to enjoy the improved predictability and sustainability of a recurring revenue business model and to serve a continuing shift in customer preferences. This shift is broad-based across our healthcare, mobile and enterprise businesses and will result, we anticipate, in further increases in recurring revenues as we emphasize our cloud-based and end-to-end solutions in clinical documentation and diagnostics, our multi-channel cloud offerings in enterprise and our connected car services in automotive. Finally, we had a strong bookings performance in the third quarter and expect second half net new bookings to outperform the first half. The trend is related to our shift to recurring revenues and it should continue in FY 2016. The combination of bookings growth and the benefit of our transformation program position us for continuing improvements in revenue growth, EPS and cash flows as we move towards FY 2016. We're now happy to take your questions.

[Operator:]

Okay, certainly. [Operator And it comes from the line of Daniel Ives of FBR. Please go ahead.

[Daniel H. Ives:]

Yeah, thanks. Solid quarter, guys. Could you talk about in terms of the transformations you're seeing in healthcare and where we are in terms of that shift going to the next six to nine months in terms of where we've been and now what you see things going forward?

[Paul A. Ricci:]

Well. Healthcare broadly is already at a very high proportion of recurring revenues. But we will see a further shift as we look out in the coming, this quarter and next year in our diagnostics and clinical documentation product lines towards recurring revenues for a variety of reasons. Some of that is migration to cloud-based solutions. Some of that is a migration to term licenses, and some of it is a result of the fact that customers, our largest customers are seeking to buy from us a combination of our solutions, and end-to-end solution that results in revenue being recognized over time. I think currently our recurring revenues in healthcare are in the range of about 75%, 80%.

[Daniel H. Ives:]

Okay. And could you talk on mobile, just is the need like the smartphone market versus automotive, maybe what's happened on automotive in terms of pricing, just what type opportunity is going to fiscal 2016? Thanks.

[Paul A. Ricci:]

Yeah, generally speaking, we've seen an expansion of our automotive business now over the last several years, and that's continuing as we've talked about in previous quarters. We had an extraordinarily strong quarter in automotive bookings this year. We referenced that I believe in the prepared remarks. Several large bookings with major automotive manufacturers that in total sum to more than $100 million. Pricing has remained good in the automotive business, in part because we've expanded our offering set to a broader solution, and we anticipate continued strength in that business as we look ahead in FY 2016. The smartphone business is a somewhat different story as we talked about in previous quarters. The consolidation of that industry, pricing in that industry have made that a less favorable segment for us as we've gone through this year, and we expect that trend to continue.

[Daniel H. Ives:]

Thanks.

[Operator:]

Okay. Thank you. You have a question from the line of Brent Thill of UBS. Please go ahead.

[Ian Strgar:]

Yeah, hi guys, this is Ian Strgar calling in for Brent Thill. Thanks for taking my question. So I was just wondering just on the cost savings and the realignment efforts, I was wondering if you could comment just broadly on how the sales and marketing realignment is going, and what product areas within each segment that you see the most opportunity to perhaps reaccelerate top-line growth in the coming quarters.

[Paul A. Ricci:]

Okay. Well, with respect to sales and marketing realignment, one has to move gradually there as you would anticipate, because we don't want to create customer disruption in the short run. And so that's a process that will be ongoing throughout the 18-month period. We have made some changes there. But we're being judicious about that just because of the disruption issue I mentioned. With respect to the growth question you've asked me, our focus, where we're focusing our investments, first in healthcare, broadly in the clinical documentation segment as well as diagnostics. In enterprise, primarily in our multichannel on-demand offering as well as our voice biometrics offering. In mobile in the automotive segment and the mobile operator services solutions; and in imaging in the network MFP business.

[Ian Strgar:]

Great. And just a quick follow-up. So then -- so on kind of EPS growth, how are you guys kind of thinking about that longer term? Like are these cost savings kind of sustainable past fiscal 2016? Or just kind of how you're thinking about EPS growth in -- beyond fiscal 2016.

[Paul A. Ricci:]

Well, the program we've defined includes about $125 million of costs through the end of fiscal 2016. And of course the benefits, the full year benefits of those savings will be available in fiscal 2017. So that will provide some EPS expansion in fiscal 2017 that we don't see in fiscal 2016. I think that's part of the question you're asking. In addition, bookings in the second half of this year are up over the first half, and we expect that bookings will show continued strength as we go into fiscal 2016 and that should create higher revenue growth as we look into fiscal 2017. That revenue growth will be further stirred in fiscal 2017, further motivated in fiscal 2017 by our migration to -- our recurring revenue migration, the migration to our cloud-based solutions, which I've referenced earlier in my opening comments. So we have all of those factors that are coming to bear in fiscal 2017. And we believe that will provide EPS expansion well beyond 2016 as we look into 2017.

[Ian Strgar:]

Great. Thanks a lot, guys.

[Operator:]

Okay. Thank you. And the next question, the final question comes from the line of Sanjit Singh of Morgan Stanley. Please go ahead.

[Sanjit K. Singh:]

Thanks for taking the question, and Dan, welcome to the team. I wanted to toggle back to the automotive business if I could. It was the big billing contribution this quarter. But in terms of revenue and the timing of when that gets recognized, what are the revenue trigger events? Is it a function of specific units shipping or sort of a sell-through process? Maybe you could help us, enlighten us on that topic.

[Paul A. Ricci:]

Well, we usually bill at the time a car is shipped, but the revenue is recognized over time, because it's a connected service and therefore has to be recognized over the useful life of that service. Our automotive bookings tend to be longer lived than most of our other bookings because, as you're aware, the useful life of an automobile is somewhat longer than many other devices. That's an attractive feature of that business in our mind, because it provides-- we are building up as our bookings continue to mount in that business -- we're building up a steady backlog of deferred revenues which create recurring revenue in that business over a long period of time and a stable foundation upon which to build.

[Sanjit K. Singh:]

Makes sense. And then back to the expense reduction plan, you've reached $50 million so far by Q3. Could you sort of review for us what's been done to-date to generate the $50 million? And then for the incremental $75 million, what's left to do, what options are you going to be pursuing to drive the $75 million by Q4 2016?

[Paul A. Ricci:]

Okay. With respect to the $50 millions, we've had savings as we I think made reference to in earlier comments. We've had savings in our cost of goods. Those were especially strong over the last six months, particularly in healthcare but elsewhere as well. We've had savings throughout our income statement, significant savings in R&D, but we have had savings in the other line items as well. With regard to savings, as we look ahead between now and the end of the 18-month period, the kinds of programs that take somewhat longer to implement are programs such as data center consolidation, facilities consolidation, other operational process reengineering that can go on to streamline the business that simply take more time or involve some systems changes. Those are the types of programs that we have planned over the next year that will result in additional savings.

[Sanjit K. Singh:]

Great. Thank you. And my last question is regarding the enterprise. Seems that's been bouncing back in bookings. What's the sustainability in terms of enterprise growth going forward?

[Paul A. Ricci:]

Well, as I referenced in an earlier question, what's going to drive enterprise growth primarily is going to be the bookings that we've enjoyed over the last several quarters and which we expect to continue in our on-demand solutions, particularly our multi-channel on demand solutions. And that really is what will drive revenues as we look ahead. And the implementation of those bookings, which take somewhat longer than some of the other businesses because of the complex back-office integrations mean that some of the bookings that occur won't realize revenue gains until, say, the second half of 2016 or even some cases, 2017.

[Sanjit K. Singh:]

Got it. Thank you very much. Congrats on a nice quarter.

[Operator:]

Okay. Thank you. Back to you, gentlemen.

[Paul A. Ricci:]

Okay, then. Thank you very much for your questions. We look forward to talking to you again next quarter.

[Operator:]

Okay. Thank you. And ladies and gentlemen, this conference will be made available for replay after 4 o'clock p.m. today through August 20 at midnight. You may access AT&T Executive Replay System at any time by dialing 1-800-475-6701, entering the access code 363855. International participants dial 320-365-3844, and again that access is 363855. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.