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Edited Transcript of NUAN earnings conference call or presentation 7-Aug-19 9:00pm GMT

Q3 2019 Nuance Communications Inc Earnings Call

BURLINGTON Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Nuance Communications Inc earnings conference call or presentation Wednesday, August 7, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel D. Tempesta

Nuance Communications, Inc. - Executive VP & CFO

* Mark D. Benjamin

Nuance Communications, Inc. - CEO & Director

* Robert Dahdah

Nuance Communications, Inc. - Executive VP & Chief Revenue Officer

* Tracy H. Krumme

Nuance Communications, Inc. - SVP of IR

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Conference Call Participants

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* Daniel Harlan Ives

Wedbush Securities Inc., Research Division - MD of Equity Research

* Jeffrey Parker Lane

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Rudy Grayson Kessinger

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

* Saket Kalia

Barclays Bank PLC, Research Division - Senior Analyst

* Sanjit Kumar Singh

Morgan Stanley, Research Division - VP

* Yi Fu Lee

Oppenheimer & Co. Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Nuance Q3 2019 Results Conference Call. (Operator Instructions)

I will now turn the call over to Tracy Krumme, SVP of Investor Relations for Nuance. You may begin your conference.

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Tracy H. Krumme, Nuance Communications, Inc. - SVP of IR [2]

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Good evening, everyone. Thank you for joining us on our third quarter fiscal year 2019 conference call. With me on the call today is Chief Executive Officer, Mark Benjamin; and Chief Financial Officer, Dan Tempesta. As a reminder, this call is being recorded.

Before we begin, I would like to remind everyone that our discussion includes predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that can cause material differences in our results. Please refer to our recent SEC filings for a discussion of these results. All references to income statement results are non-GAAP unless otherwise stated. As noted in our press release, we also issued prepared remarks in advance of this call, which can be found on our IR website at nuance.com. These remarks are intended to supplement our comments on this call today.

And with that, I would now like to turn the call over to Mark. Mark, please go ahead.

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [3]

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Thank you, Tracy, and good afternoon, and thank you, everyone, for joining us. I'm very pleased with our Q3 performance as once again we delivered on our strategic and financial objectives. We delivered solid revenue performance across each of our strategic business segments and achieved strong operating margin.

Transitioning our solutions to the cloud continues to be a top priority and our margins once again benefited from a favorable revenue mix shift. Margins were also aided by our ongoing operating expense reduction programs which are giving us room to invest more aggressively in our key priorities.

We continue to execute on the strategic plan that we rolled out last November. As a reminder, that plan includes a focus on revenue growth, significant self-funded investments in key product initiatives and a simpler, more scalable operating model with a responsible capital allocation strategy. These are busy times at Nuance so I'm incredibly proud of the hard work, intense focus and great results that our more than 8,000 associates delivered in the most recent quarter.

Turning now to some of the specific highlights in the quarter. First, Healthcare revenue increased 2% year-over-year or 5% excluding the expected declines in our nonstrategic HIM and EHR implementation services businesses. Our higher margin recurring Dragon Medical cloud revenue grew for the 16th consecutive quarter as we win new business and continue our cloud transition.

Second, Enterprise revenue grew 8% year-over-year led once again by strong performance from our omnichannel cloud offerings.

Third, Automotive delivered another great quarter with 8% revenue growth, marking 13 consecutive quarters of organic growth. The Q3 strength was due to growth in our connected car solutions, new design wins and deployments in more models across our customer base. We made excellent progress towards the spin-off of this business which I'll discuss in more detail.

Fourth, we sold our noncore SRS business. This enabled us to exit the business in 9 months versus the 12 to 24 months we initially expected while providing a better result for Nuance and our customers.

And finally, in line with our continued focus on capital allocation, we repurchased 1.7 million shares during the quarter. This brings our total share repurchase through the first 9 months of the year to 7.7 million shares or approximately 3% of shares outstanding.

With those highlights, let me provide some additional color on some of our accomplishments in the quarter. In Healthcare, the trends continue to move in the right direction and we feel good about the strength we've shown in booking new annual recurring revenues or ARR. We see meaningful additional opportunity to expand our Dragon Medical cloud footprint into the mid-market acute and ambulatory facilities and are building a direct sales force and targeted go-to-market efforts to capture this opportunity. We expect these investments, which were already contemplated in our investment framework for the year, to yield incremental ARR growth.

Our international markets continue to scale, with strong Q3 performance in Germany and France. Notably, we see early interest from some of our new clients to start our cloud-based solutions rather than taking a more tempered approach by starting off with our on-premise solutions. This international growth opportunity has the potential to become a meaningful contributor to our ARR during fiscal year 2020 and beyond. We had several key international wins in the quarter such as Imperial College Hospital in London, CHRU Nancy in France and Skåne Regional in Sweden.

In radiology, we are beginning a transition to the cloud with our new AI-driven PowerScribe One solution. We had important validation at the June annual meeting for the Society of Imaging and Informatics for Medicine. In addition, the University of California, Summa Health and Massachusetts General Hospital made presentations confirming the importance of our integrated AI radiology solutions into their workflow and the positive outcomes they've achieved with our solutions.

We're also beginning to migrate our installed base of clinical documentation improvement customers to the cloud with our CDE One offering. This is gaining significant momentum as clients look to deploy advanced AI technologies into their revenue cycle workflow. We have released new analytic capabilities to our cloud offering and increased our focus on specialty solutions like Nuance Surgical CAPD, which saw strong uptake in the quarter.

I'm excited about the early traction that our cloud-based PowerScribe One and CDE One products are showing. As we look ahead, these 2 cloud-based solutions will start to become meaningful contributors to Healthcare's cloud-based subscription ARR. These products have been exceptionally well received in the market and both have powerful on-premise to cloud transitions ahead with beneficial revenue and profit uplifts that will contribute meaningfully to our business model, just as we've seen with our DMO transition.

We're also gaining momentum with our Ambient Clinical Intelligence technology which we refer to as ACI for short. Dubbed the exam room of the future and unveiled in February at HIMSS, ACI has the potential to be a real game changer for Nuance and for the industry. During the quarter, we signed Nebraska Medical and EmergeOrtho as strategic partners with initial commercial rollouts expected later this year. We have several more Healthcare organizations that we are looking to partner with in the short term and are pleased with the progress we're making here. ACI has the ability to dramatically change the way doctors document the patient visit by capturing the relevant elements of the encounter. Early feedback has shown that this has the potential to revolutionize clinical documentation while dramatically reducing physician burnout caused by excessive administrative burdens.

Switching gears to our Enterprise segment. We once again had a strong quarter led by better-than-expected transactional volumes and services within our omnichannel cloud offering. This was driven by expansion at a number of existing customers and new logos going live. This is especially true within digital engagement which includes messaging, virtual and live chat capabilities. Several key wins across the portfolio include the Bank of Montreal, Charter Communications, FIS and Maxi Mobility Spain.

Honing our solutions and developing state-of-the-art technologies is a critical priority, and we continue to make notable investments and progress, particularly in our voice biometric segment. Here, we unveiled Nuance Lightning Engine, which combines voice biometrics and NLU to authenticate individuals within seconds of speaking to deliver personalized responses. New solutions like this pave the way for our next customer win, setting new bars for innovation, and I'm pleased that we're leading the way. To that end, Santander Bank joined the growing list of leading enterprises successfully leveraging or biometric solutions.

In addition, we announced a strategic partnership with Mila, a world-renowned, Quebec-based AI research institute, and opened a new lab in Montreal. This exciting partnership will bring us closer to the academic AI research community and enable us to further advance our machine learning applications, especially for language and image processing. The lab will serve as an extension of our own Montreal office, which is one of our key global research sites, and that was recently named one of Canada's top employers for young people as well as Montreal's top employers. We have an incredible research team which has been at the forefront of conversational AI innovation for the past 20 years. Partnerships like this strengthen our ability to attract top talent and stay on the bleeding edge of AI techniques and applications.

The industry analysts are also taking note of our progress. During the quarter, we received significant recognition by both Forrester Research and Opus Research. Forrester recognized Nuance as a leader in the new wave conversational AI for customer service, noting that our conversational AI deployments markedly improved customer experience. And Opus named us the undisputed market leader in their Intelligent Authentication and Voice Biometrics Intelliview report. These are incredible distinctions and I congratulate our Nuance team for these accolades from these third-party influencers.

Moving to Auto. As I mentioned earlier, we made significant progress towards the spin-off of the business and for it to thrive as an independent company. We remain on track for an October 1 spin. Earlier this week, we announced the company's new name, Cerence. During the quarter, we announced that Sanjay Dhawan will become the CEO of Cerence upon the spin. Sanjay brings 30 years of technology and automotive experience, most recently as CTO and Division President of Harman. He has extensive relationships across the sector and we look forward to his leadership.

We recently hired Mark Gallenberger as the CFO for the new company. Mark brings significant public company CFO experience, most recently serving 19 years at Xcerra Corporation, formerly LTX-Credence, as its CFO, COO and Treasurer.

And just today, we announced the future Board of Directors for Cerence. This Board will be led by industry veteran and former Vodafone CEO, Arun Sarin, as the Chairman. It is an incredibly talented and diverse Board with a wealth of experience from leading companies such as Motorola, Aetna, Qualcomm, PTC, USAA, athenahealth and many others. If you haven't already, I encourage you to review the release we issued this morning. I'm confident that this Board, along with Sanjay, Mark and the rest of the talented leadership team will lead Cerence to success in this new and exciting next chapter.

Coming off another strong quarter, momentum favors our Auto business today. Let me share a few highlights. 33 new vehicle models from 13 brands moved into deployment, including Porsche Taycan, Mercedes-Benz GLE, MG Motor India, an extension of our work with S-A-I-C or SAIC. We secured new design wins in Europe, the Americas, Korea and China with OEMs including BMW, Porsche, PSA, Geely and Toyota as well as Guangzhou and SsangYong. We signed our first customer, a large German OEM, for our new siren detection solution as well.

Our China business celebrated a significant launch in select cars from Geely, china's fastest-growing automotive manufacturer. Our technology is part of Geely's smart ecosystem, an innovative digital cockpit that integrates infotainment, connectivity and vehicle management. With wins like this and others, we are building important momentum in China and India, the world's fastest-growing auto markets.

Also, we recently celebrated a Bosch Global Supplier Award. Out of 43,000 suppliers, we were 1 of only 47 and the first software company to be honored with this award.

Overall, I'm proud of our team and what they've achieved, particularly how they've stayed focused and on track during this period of significant transition and distraction. Their hard work and dedication has built a strong foundation for Cerence. This is the last time that we will formally and at length talk about the Automotive business.

Since joining the company last year, I have been impressed by the business, the team, our dedicated customers and the huge market opportunity. Quarter in and quarter out, this business has delivered exceptional results evident in 1 of every 2 cars shipped globally today. While it's bittersweet to see Auto leave Nuance, this is a great outcome for the company, our shareholders and our associates. On the latter, this entire team that spans more than 1,500 associates has my deep respect and admiration for all that they have built. Starting 2 decades ago, the team, many of whom are here today, had a grand vision for the future of mobility and in-vehicle assistance. The business has accomplished so much over the years and I'm certain its best times lie ahead. I wish Cerence, its employees and customers all the best during this new, exciting time.

And with that, I'd like to turn the line over to Dan.

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Daniel D. Tempesta, Nuance Communications, Inc. - Executive VP & CFO [4]

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Thanks, Mark, and good afternoon, everyone. As Mark highlighted, we had a very good third quarter and are well positioned for a strong finish to the fiscal year as we enter our fourth quarter.

Our revenue for the third quarter exceeded the midpoint of our guidance by $4 million due to strength in our Enterprise omnichannel cloud offerings. In addition, both Healthcare and Automotive segments once again performed well and were in line with our expectations.

Within Healthcare, several of the trends we experienced during the first half of 2019 continued during the third quarter. First, Dragon Medical cloud continued its quarterly sequential revenue growth, albeit at a slightly slower dollar increment compared to recent quarters. While our bookings pipeline for these offerings remains strong and in line with our annual expectations, the timing of those bookings is back-half loaded, which is not uncommon for our Healthcare business. This has the effect of driving later implementations and therefore, later revenue recognition.

As we have discussed in the past, there is a strong correlation between the pace of uptick for Dragon Medical cloud and the corresponding decline of our on-premise Dragon Medical maintenance and HIM revenues. These 2 lines were strong during the quarter, but we expect that as Dragon Medical cloud conversions resume their strength, maintenance and HIM revenues will continue on their pace of decline going forward. As a result, we see the slightly delayed Dragon Medical cloud revenue as a matter of timing and place greater emphasis on ARR signings to evaluate the momentum of our business and the related cloud transition. In this regard, based on the strength of Dragon Medical bookings pipeline, we are on track to achieve the mid to high end of our full year ARR guidance range of $245 million to $255 million.

Rounding out our Dragon Medical discussion, on-premise license revenues declined in line with our expectations, but this decline was somewhat offset by the ongoing strength in our international markets where we continue to see results from some of the new market penetration successes Mark mentioned earlier. Our radiology and other business grew 9% on a year-over-year basis, but also experienced a modest sequential decline. You'll notice that this trend occurred last year as well. And since there remains a meaningful amount of revenue in this category that is not cloud-based or recognized ratably, we can experience volatility from quarter-to-quarter. We remain excited about the potential to unlock shareholder value in this segment as we begin our transition to our cloud-based PowerScribe One offering. Like Mark, I am very encouraged by the early traction we are seeing for the cloud solutions within our different Healthcare business lines, specifically in radiology and in CDI, and expect that they will contribute meaningfully to cloud subscription ARR in the years to come.

Lastly, in Healthcare, we continue to experience volatility in our low margin EHR implementation services, though our results were generally in line with our expectations this quarter.

Our Enterprise segment delivered another strong quarter and has shown exceptional consistency during fiscal 2019, and we're particularly pleased with the strength in our cloud volumes. For the 9 months, the division has experienced 8% year-over-year revenue growth.

Turning to margins for the company. Non-GAAP gross margin was 61.1%, up 130 basis points year-over-year. This was primarily due to the continued revenue shift to Dragon Medical cloud and the expected declines in low margin HIM revenue. Non-GAAP operating margin was 27.9%, up 440 basis points year-over-year and was better than expected. This was due in part to the strength in gross margins and accelerated savings from our cost programs, partially offset by the ramping of our priority investments.

As we entered 2019, we knew that balancing the timing between cost savings and our new investments would be a challenge, potentially causing short term profit variations. And as a result, we made sure to call it out each quarter. While we are pleased with our operating margin overperformance, we note that we will continue to increase these critical investments in the fourth quarter and into fiscal year 2020. Therefore, I would caution against extrapolating any margin expansion too aggressively into the future periods without consideration for these investments. Of course, we expect that these investments will ultimately drive a positive return.

The net effect of these items, combined with our capital allocation actions during the quarter and the year, led to very strong EPS results. We came in at $0.31 compared to $0.22 a year ago. And once again, we landed above the high end of our guidance range of $0.26 to $0.29.

In the third quarter, we repurchased 1.7 million shares of our common stock at an average price of $17.36 for a total consideration of approximately $30 million. And since May 2018, we have repurchased approximately 6% of our shares outstanding at an average price of $14.71. This leaves us with $436 million available under our existing authorization for share repurchases.

During Q3, we generated cash flow from operations of $94 million and ended the quarter with approximately $680 million in cash and marketable securities. Our ability to generate strong cash flows gives us exceptional flexibility to both reinvest in our business and return value to our shareholders.

We remain very happy with our balance sheet and our strong cash balances with a net leverage ratio of 2.5x, down from 2.7x last quarter. As we look ahead to the Automotive spin, we continue to expect that the stand-alone Automotive business will be levered. This will enable us to bring additional cash back to Nuance upon completion of the transaction. At the time of the spin, we would expect Nuance to be net leverage neutral, which will provide great flexibility related to capital allocation alternatives. Our objective remains for both companies to have effective capital structures immediately following the spin.

Now turning to guidance. For fiscal year 2019 revenue, we are maintaining the midpoint of $1.86 billion, which accounted for the SRS sale transactions. We are also providing a more narrow guidance range of $1.85 billion to $1.87 billion. While the midpoint revenue guidance for the company remains unchanged, the composition of revenue within the Healthcare business has been modestly updated, primarily reflecting the lower Dragon Medical cloud revenue with corresponding increases in Dragon Medical maintenance and HIM revenues to account for the timing-related variations I discussed earlier.

As I also mentioned, I remain confident in our Dragon Medical ARR pipeline and are maintaining our range of $245 million to $255 million. We are reaffirming our fiscal year 2019 gross margin guidance at 62% and we are raising our operating margin guidance range by 25 basis points to a midpoint of 27%. This reflects the dynamics I have discussed between accelerated cost savings and our ramping of strategic investments.

For 2019 EPS, as we now enter the fourth quarter, we are narrowing our guidance range while also raising our midpoint expectation. Our new range will be $1.14 to $1.20 compared to a range of $1.12 to $1.20 provided in June. Our 2019 free cash flow guidance range slightly improved as we now expect less capital expenditures than previous guidance for a revised range of $305 million to $360 million.

We have also updated our cash and marketable securities projections in order to account for the $30 million of share repurchases we executed during the quarter and the lower CapEx to a range of $725 million to $775 million.

In closing, we continue to put our energy into creating a simpler company while also converting many of our products into offerings that are more cloud-based and recurring. As you heard from our comments, this work is well underway and Mark and I are very pleased with the performance we've achieved during 2019.

Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Dan Ives from Wedbush Securities. And your next question comes from the line of Saket Kalia from Barclays Capital.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [2]

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Mark, maybe just to start with you. A lot of talk about some of the new cloud-based solutions. Sounds like we can think about some traction on the contribution here in 2020. Some of the solutions like radiology, CAPD and ACI, can you just dig into those a little bit more and how you think about those potentially contributing in 2020?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [3]

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Sure, sure. Also, for those on the call, we have Rob Dahdah on the line here as well with us. So we introduced him last quarter as the Global Head of Sales. So he's wide open to take any of your hard questions. But Saket, regarding the cloud growth story here, something that we really spoke about when we launched the strategic plan, if you will, back in November, really about on the back of a great Dragon Medical cloud or DMO story, we have a number of evolving cloud solutions that have historically either been sold here as a license or in some cases really just new products to the mix.

So relative to radiology, I guess you mentioned that one, our PowerScribe base, which is a market leader in the radiology field, we have launched that product. We did this year at RSNA. And PowerScribe One is essentially already in the hands of the sales force where we're seeing exceptional demand. So we once believed that a solution like that would sit on-premise. Obviously, there's great appetite to increase functionality, improve version control, essentially allowing clients to always be on the current version and to have lower hosting costs and improve security by moving over to our cloud-hosted solution. So that's one very good example. Not contributing today to ARR, it's something that we'll probably when we turn the fiscal year start to include. And we'll obviously cover this in November. So we see great excitement in the market for that.

CDI, clinical documentation improvement, also a similar story. Sitting down below the Dragon Medical family today, not included in ARR. As CDE One comes to the market, again, while we don't have a lot of market penetration such as in the PowerScribe base, this really becomes a greenfield opportunity to help grow the business with a cloud solution. So those are just a couple of examples.

CAPD and DMA, which you've heard us talk about, are solutions in the Dragon family today are just beginning to gain some momentum and contributing to ARR. We announced this quarter, Saket, the expansion of our CAPD that cover the surgical segment clinician, if you will, and we're seeing great traction with that very early.

So again, everything that we're focused on here is around growth, around recurring models and around cloud-based architecture and hosting environment. So we're excited. Certainly, these will all contribute in '20 to ARR growth. But we're just, obviously, here in the fourth quarter, just trying to finish the year in a positive way.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [4]

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Got it. That's helpful. Dan, maybe for you. Obviously, a lot of moving parts this year with a couple of divestitures. I guess on the revised cash flow guide, like the increased cash flow guide, I believe, you've given here for fiscal '19, I guess how much would you sort of attribute to the Auto business? And how much would you call out in terms of being restructuring-related, so legal, advisory fees, any sort of onetime significant cash outlays here in '19 as well as for the Auto contribution which we wouldn't expect to repeat in future years, how would you size that?

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Daniel D. Tempesta, Nuance Communications, Inc. - Executive VP & CFO [5]

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Yes, Saket, great question, both of them. So we haven't yet disclosed the details of the Auto cash flows. And we will do that, of course, in short order as we start to talk more about the business and get the spin ready. But I would say, a good framework to consider would be the profit model for the Auto business. So we've got 35% to 37% segment margins that we discussed. If you then put a G&A load on top of that of 6% to 7%, you're sort of in the operating margin range of around 30%. And that's a good proxy for sort of the income that, that generates, plus some deferred revenue benefits that we talk about every single year that the Auto business enjoys. That puts you in the rough ballpark for cash flows for the Auto business.

As related to the restructuring, we sure have had a lot of change this year. So when you think about the restructuring and cost initiatives that we've had during the year, the Auto stand up, the Auto separation, the Imaging separation, and a lot of that is still occurring. I think you should probably think of that slightly over $100 million or so of cash flow impacts. But I guess the last thing I'd say about that is, as you look forward, 2020 is still a big year for us of change. We talked about this. Once Auto is behind us effective October 1, we then have to get onto the difficult work of some of this stranded costs. And of course, the TSAs are winding down for Imaging and so there's still some cost work that happens the first half of 2020.

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Operator [6]

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Your next question comes from the line of Sanjit Singh from Morgan Stanley.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [7]

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Congrats to the team on a strong execution quarter ahead of the Automotive spin. Really nice to see, in particular the operating margin improvements were very impressive. Mark, maybe if I were to talk about the Dragon Medical cloud business and maybe this is actually better targeted at Dan. If we think about the composition of that ARR guidance of $245 million to $255 million, how much of that ARR represents the physician base? So the 550,000 roughly physicians that are on the Dragon Medical platform today, how much of that is on Dragon Medical cloud? What percentage of ARR does that represent?

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Daniel D. Tempesta, Nuance Communications, Inc. - Executive VP & CFO [8]

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This is Dan. Thanks, Sanjit. What we've talked about is, we're probably 2/3 of the way through our transition. But a good way to think about it is, at the beginning of the year, we said 30% of the doctors in the U.S., that 925,000 doctor count that we always provide were subscribers to Dragon Medical cloud and at the end of the year will be in the 38% to 40%. So that gives you the rough math of where we land at the end of the year against that 550,000.

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [9]

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Yes. Sanjit, this is Mark as well. So the way DMO growth takes place, there's a number of ways that, that line grows. And the ARR there is essentially Dragon Medical cloud, the majority of that number, the large majority of that number. So obviously, sales drive ARR with new units, with new customers; when we sell existing customers using a license and on M&S and then ultimately we upgrade our legacy transcription or HIM customers. So there's really 3 ways to grow that DMO line which obviously contributes to ARR. And then as we layer on our other solutions around DMA, CAPD, CAPD surgical, that continues to sit in that same category to drive ARR.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [10]

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Understood. And then if I could ask a question on the Enterprise business. It's been a really consistent performer over the last year, frankly. And I was wondering if you can give us a sense of the omnichannel cloud offering. Who are you sort of competing up against in that space? And what's sort of driving the nice win rates that you're seeing that's helping you sustain what's been really solid Enterprise growth over the last several quarters?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [11]

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Yes, I mean, we agree. And you know our business has largely been a voice-based business, think of IVR. And over the last 2 or 3 years, and credit to the management here, moving us really to that digital space. As you know, we also did an acquisition about 2, 2.5 years ago to really accelerate our digital footprint. And when we talk digital, we're talking around virtual agent, chat, just to cover a couple of the aspects. And now we're seeing really good traction with this cloud solution in our digital space where we have customers, volumes and transactions growing and new customers coming online. And we're seeing great volume growth. So transactions don't necessarily equate to the same growth rate as revenues, but we're seeing, again, very impressive, what we would suggest as kind of market-leading growth rates in the up end of the market that we play. We have a wide competitive set of named competitors that we see, a lot of which perhaps you read about don't necessarily play at the up, up end of the market, but certainly we'll see, occasionally, we'll see a live person and some other types in that category.

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Operator [12]

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Your next question comes from the line of Jeff Van Rhee from Craig-Hallum Capital.

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Rudy Grayson Kessinger, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [13]

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This is Rudy on for Jeff. A couple of questions for me. So I think starting with a sort of a two-part question with the HIMSS line and DMO cloud line. I know HIMSS, I think, this quarter that sort of declined, eased out a bit. I think it was down 9% year-over-year. And I know you lowered the guidance to a 16% decline. Is that moving forward now going to be in that? I know you've said 10% to 15% before. Does that still hold? And then on the DMO cloud line, if we think about maybe a 2-, 3-year growth rate for that line ex the migrations, what has that line grown organically ex-ing the migrations?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [14]

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Yes. So I'll cover off and then Dan can certainly follow-up. I think when you look at the clinical capture category that we have in the prepared remarks and we talked about it in our opening remarks, essentially, HIM had a couple of conversions, really 2 large conversions in the quarter that didn't convert on schedule to DMO. And that obviously reduced the negative growth rate. And you saw a little bit of goodness in the HIM line which we don't mind degrading down at the benefit of DMO. So think of 1.5 type of million dollars of increased revenues in the HIM category at the expense of a roughly similar number in the DMO growth line. DMO will still grow in the 50s, 50-ish or so percent, mid-50% category for the year. So again, a little bit of timing, but you see the relationship which is what we've essentially been talking about and growing the DMO business.

I think from a runway standpoint, we still have, I think, a very good runway ahead as far as converting both our DMNE, which is on the license, maintenance line as well as our HIM customer base, quite honestly, for several years to come. So by no means do we think this is a late inning type of conversion model. And you heard Dan just a minute ago talk about really gaining to that 38%, 40% market share for DMO. We've said before also roughly half our growth comes from, if you will, organic and the other half really comes from the conversions. So we continue to see that kind of ratio hold and we feel very good about the business going forward.

Don't forget, we have also these other aspects of our cloud solution, not just CAPD and into multiple specialties. Certainly, we're moving DMO down into the mid-market. That's one of our stated investments back from November that we're making good progress towards building DMO internationally. It's largely a U.S. or North America-centric solution today. Just planting the seeds, gaining traction internationally for DMO, and that would obviously be all organic growth and it would drive the growth rate, but we would expect an accelerated growth rate organically. So that's essentially how we're looking at the business for the next several years. Not to mention ACI, which is certainly in the out-years, but will drive cloud growth in the clinical capture category.

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Rudy Grayson Kessinger, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [15]

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Great. Got it. Great color. And the next one I just want to follow up on was the ACI. I know you called out Nebraska Medical and EmergeOrtho earlier in the call. And I believe I heard you say that they're in beta trial period right now but expected to have full commercial launches towards the end of this year. And just mapping that, I think previously you guys had said the early specialties were to be released in early '20. So if you could just give maybe an update on the time line there of when you see those early specialties coming to market and then longer term how you see those rolling out moving forward?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [16]

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Yes. I mean, I think the time line hasn't changed at all since we really started to disclose that more publicly. And the specialties that will go beyond early beta but into the field at select sites is still on track, same 5 specialties. Quite honestly, we don't have a demand issue around our ACI solution. That's obviously a great problem, if you will, a great thing for us to have. It's really, right now, we're very focused on the technology, the solution, the capability and making sure that we bring our partners along for the early stages. In '20, you'll see those 5 specialties and behind the scenes, if you will, we'll be again targeting another 15 to 20 specialties that we'll slowly start to ramp. These are, I'd say, at the extreme, the most advanced AI, ML-type models that Nuance has really produced in its history. So these are solutions that learn as they go. They get smarter with more throughput. And that's essentially how the specialties begin to ramp over the next 2 to 3 years going forward.

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Operator [17]

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Your next question comes from the line of Tom Roderick from Stifel.

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Jeffrey Parker Lane, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [18]

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It's actually Parker in for Tom. So you called out some strength in the international markets with Dragon Medical licensing and I just wanted to drill down on the whole road map there for the cloud transition. Can you talk about some of the technological challenges that have prevented customers from going directly to cloud in the past and why now is the right time for customers in areas like Germany and France to really be thinking about going to the cloud offering?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [19]

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Parker, so I think, quite honestly, it's a market that did not have a pronounced focus for the company. We were largely a reseller or VAR-type model. Speech kits were more of the solution and certainly none of it was cloud-based. And I think when we did this portfolio review that you and Tom would certainly remember back, I guess, a year ago, this is one of the opportunities with our research and with the analysis that we had done to say, the markets there are ready for cloud and hosted solutions. And certainly, we're ramping our sales force up. We're working on all of our hosted solutions. Obviously, we're dealing within an EU framework around data privacy. And certainly very, I think, sensitive data when it comes to health care. So obviously, respecting all requirements is key. We think it's a differentiator for us as far as what we're willing to invest to make sure that's where it should be. So again, I think what you're hearing from us is our Dragon license business is doing very well. We see very good market acceptance. We're also now seeing customers or prospects wanting the DMO solution, the cloud solution faster than, quite honestly, we're even ready to give them, but we're working very hard. So I don't know, Rob, if you have anything to add to that?

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Robert Dahdah, Nuance Communications, Inc. - Executive VP & Chief Revenue Officer [20]

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No. I think that's well said. I think moving forward, especially in Europe, as this becomes something that all the potential obstacles that Mark mentioned are all issues or obstacles that we can overcome. None of them are deal breakers. And we actually are well positioned right now to be able to have strong solutions in all the key markets that we've identified prior to going into the year. So we feel like we're very, very much on track for our growth plans in Europe.

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Jeffrey Parker Lane, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [21]

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That's great feedback. And I guess this is the opportunity to ask you, Rob, what the sales coverage looks like in international markets like Europe and whether or not you need to invest further going forward to really address this opportunity?

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Robert Dahdah, Nuance Communications, Inc. - Executive VP & Chief Revenue Officer [22]

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Yes. Thanks for teeing that easy one up for me. We definitely are investing. That's part of our plan going into the year and we're positioned well to further invest in sales headcount as these solutions come online. So we're able to sell into them. Part of it is, culturally, in the past, we've sold in a different model. So we are identifying in addition to upskilling the folks we have, identifying the right talent to bring on board that sells in the new model. And so very much aligned to our opportunities there and excited to have the company's backing on that investment.

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Operator [23]

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Your next question comes from the line of Dan Ives from Wedbush Securities.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [24]

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It's a great quarter. So obviously for Rob and Mark. My question is in terms of in the sales force and just overall from a customer perspective, maybe talk about where you think the low-hanging fruit in terms of what you're seeing so far in the field versus maybe over the next 6, 9 months where you think there could be some major sort of opportunity in terms of penetrating the installed base?

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Robert Dahdah, Nuance Communications, Inc. - Executive VP & Chief Revenue Officer [25]

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Thanks for the question. I'll take a run at that. I'd say that there's always competitors out there so there's no easy pickings. But there are markets that are underserved and I think Mark and Dan mentioned them earlier. In the mid-market space, we have an opportunity to go in and really expand in an area that previously really didn't have much attention from any of the big players. And certainly, we're, I think, as well positioned as we've ever been in that space, not only in intent but in action because we have a team staffed up and we're ready to go in that space. So that's an exciting new development for us.

You heard me talk a little bit earlier about where we have opportunities internationally to go play. And as Mark mentioned, the strength of our offering is a differentiator because it's fully compliant, it's locally available and we're in a strong position there. So I think those are a couple of good key areas. But there are other areas where historically we might have been not as introspective as we've been. I think the team prior to me coming on board and then obviously now that I'm here, we've really had a good hard look internally of where we could expand our opportunities. And now we have, as we look out, really some strength in domestic markets to look at territorial coverage of our teams. And again, the company has been willing to invest in expanding the sales force in those spaces. And so I think we have just great opportunity in our existing markets to expand just with additional coverage. So those are just a few to name.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [26]

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Just as a follow-up, I was going to ask, in terms of Healthcare and just a lot of those deals, are you starting to see larger deals, more almost hospital-wide deals? Is there a change in the pipeline when you're starting to see, especially on the cloud side, those types of deals improve transaction potential sizes?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [27]

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Rob, you want?

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Robert Dahdah, Nuance Communications, Inc. - Executive VP & Chief Revenue Officer [28]

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Yes. I think, I don't know. I think we have a good mix, frankly. I mean, historically, we definitely did deal in the larger end of the market because we have the scale and the ability to deploy quickly in that space. But I think we're starting to see now in Healthcare, but in all of our business, the opportunity to go into the mid-market and the -- not only the opportunity but the ability. We have products and now we have folks in that space to be able to deploy. So I think we benefit from a wider range than ever.

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [29]

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Yes, Dan, this is Mark. So I think Rob said it spot on. I mean, I think since he's joined and it won't surprise you, he's, I think, done a very nice job looking at sales coverage models, where our revenues and bookings have been historically coming from, the concentration of those. And in addition to the strategic investments that we started before his arrival, I think Rob recognizes that while we have been historically very acute at the high end of the market focused with our Healthcare sales force in addition to having the mid-market opportunities which is all new, all organic, hiring of salespeople and teams. By the way, we have the product in DMO ready, so it's not as if it's a road map issue. And I think Rob's also recognizing the opportunity for territory coverage and productivity even in the acute space. But I think that's just in the North American model. I mean, I think the crux of your question was, have we seen a change in any buying patterns at the up end of the market which I think the answer is no. Certainly, the ambulatory or outpatient model is being embraced by the large networks or IDNs as well. So I think all of this really is in our favor to really create some good momentum from a sales force standpoint. And of course, Rob is putting all the right kind of incentives and recognition programs in place that our hundreds of salespeople tend to really appreciate and get motivated by. So we're in our fourth quarter, as you know, Dan, so we have a lot of excitement and a lot of energy in the system to finish strong on the sales side.

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Operator [30]

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Your next question comes from the line of Shaul Eyal from Oppenheimer.

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Yi Fu Lee, Oppenheimer & Co. Inc., Research Division - Associate [31]

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Congrats on the quarter and the revised guidance. This is actually Yi in for Shaul. Just have 2 quick follow-up question, one piggying back off of Dan's earlier question with regards to the geographic expansion mix. Seems like France and Germany have performed very well during the quarter, I was wondering if you could give us more color on the, I guess, revenue split between like the geographies, whether the EMEA, APAC as well as U.S.

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [32]

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Yes. So Yi, thanks for the question. I'll take this one. We're avoiding talking about any specific one country in revenue and certainly any ARR by country. Our footprint is still very, I think, early stage. I think we're seeing strength in France, Germany. We're seeing strength in the Nordics. We've had business throughout -- out of places like the U.K. and Australia where we're seeing, I think, good traction as well. But we really don't get into the level of detail other than just kind of the quarterly messaging of really where we had kind of exceptional performance in any specific country or region.

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Yi Fu Lee, Oppenheimer & Co. Inc., Research Division - Associate [33]

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Fair enough. And my follow-up question just is about capital allocation objective. Understood that buyback is one component of it and the business has been generating healthy free cash flows. I was wondering besides buybacks. And I know the Auto spinoff is scheduled later this fall on October 1. I guess once that's done, what are the, I guess, capital allocation priorities? Like what would Nuance like to invest in, areas of investment?

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [34]

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Yes. I mean, we've been very focused on this topic for the last year, near 1.5 years and balancing share repurchases that we view as opportunistic and at good values, of course, and show the confidence that we have in the company. Also, at the same time delevering our balance sheet a bit which has been another important priority for us, which we've done and I'm proud of the team for kind of the performance and the outcome here today where we could talk to you about a 2.5 net leverage rate which is a far cry from where we were just even a year ago. So those will continue to be, I think, front and center in our capital allocation priority list. And certainly, as we see the opportunity to advance our strategy or accelerate growth within the company, we will consider M&A opportunities certainly as really kind of that third leg of how we prioritize the use of capital and as we have been and as we'll continue to do. So it's not necessarily any hard pivot, but it's certainly one that I think our balance sheet will enable us to consider as a part of our strategy.

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Yi Fu Lee, Oppenheimer & Co. Inc., Research Division - Associate [35]

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Congrats on the quarter.

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Operator [36]

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I will now turn the call back over to Mark Benjamin for closing remarks.

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Mark D. Benjamin, Nuance Communications, Inc. - CEO & Director [37]

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Okay. Well, thank you everyone for joining us and we appreciate the questions. Thank you.

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Operator [38]

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This concludes today's conference call. You may now disconnect.