Nuance Communications (NUAN) Q1 2019 Earnings Conference Call Transcript

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Nuance Communications (NASDAQ: NUAN)

Q1 2019 Earnings Conference Call

Feb. 7, 2019 5:00 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Ladies and gentlemen, thank you for standing by, and welcome to Nuance’s first-quarter and fiscal-year 2019 conference call. [Operator instructions] As a reminder, this call is being recorded. With us today from Nuance are: Chief Executive Officer Mark Benjamin, Chief Financial Officer Dan Tempesta, and Senior Vice president, Corporate Marketing and Communications, Richard Mack. At this time, I would like to turn the call over to Mr.

Mack. Please go ahead.

Richard MackSenior Vice president, Corporate Marketing and Communications

Great. Thank you. Before we begin, I want to remind everyone that our discussion this afternoon includes predictions, estimates, expectations and other forward-looking statements. These statements are subject to risk and uncertainty that can cause material differences in our results.

Please refer to our recent SEC filings for a discussion of these risks. All references to income statement results are non-GAAP unless otherwise stated. And as noted in our press release, we issued prepared remarks in advance of this call which are available on the IR portion of our website. Those remarks are intended to supplement our comments on this call today.

Please make sure you’ve selected a ticker.

For today’s call, Mark will cover our first quarter highlights and provide an update on our progress and direction. Dan will discuss our financials and guidance at greater length, and then we’ll open the call for questions. To begin, I’ll turn the call over to Mark.

Mark BenjaminChief Executive Officer

Thanks, Rick. Good afternoon, and thank you, everyone for joining us to discuss our first-quarter results. As you saw in our materials today, we got off to a great start this fiscal year, delivering a strong first quarter marked by several key accomplishments. First, we again set out and delivered on what we said we would do, and we even outperformed in several fronts.

Second, we made great progress in our growth areas, including Dragon Medical cloud offerings, our International Healthcare expansion, Automotive and in security and biometrics. Third, we hit additional milestones for a more simplified and focused company. And finally, we delivered on our capital allocation programs with recent share buybacks and our other planned debt pay down in March. Overall, I’m incredibly proud of the way our team performed, continuing its great momentum coming out of Q4 ’18.

Today, we’re going to take a little longer than we normally would on these calls, especially in the financials section. I recommend staying with us as there are a number of important details associated with the Imaging sale and creating a new baseline for the business and our continuing operations. This is especially relevant in our discussion of guidance in favorable trends. As you saw in our press release and prepared remarks, we delivered strong results across our P&L.

In particular, we delivered revenue, margins and EPS above our expectations, driven by meaningful progress in our growth and cost initiatives. You also saw that we introduced several accounting updates regarding ASC 606 and discontinued operations from the Imaging sale. So it’s important to note that notwithstanding these updates, we overdelivered on our core financial metrics and have detailed the numbers in our materials to avoid any confusion. In Healthcare, we’re off to a great start.

We strengthened our cloud offerings, especially Dragon Medical One, or DMO, one of the crown jewels of the company. Given the performance of this product in Q1, we have subsequently raised guidance for DMO for the full fiscal year. As a result, we also feel particularly good about the range we provided for the annual recurring revenue metric that we introduced the last quarter, which is a leading indicator for our cloud business. Our pipelines are healthy, and this is exactly the type of high-quality, recurring sticky revenue that we want, as it generates strong margin and cash flow.

Our Healthcare cloud offerings are one of the brightest opportunities for us. To that end, in Q1 at RSNA, the leading radiology event, we unveiled a new AI-based cloud version of PowerScribe, a radiology platform that will be available later this year. Customer reception at the event and in sales conversations has been overwhelmingly positive and we look forward to bringing this to market. We also continued our momentum in both acute and ambulatory markets, and celebrated a number of important customer deployments that include Johns Hopkins, University of Rochester, Concorde Hospital and Vanderbilt University Medical Center.

I would be remiss if I didn’t point out the strength in the upward revised guidance for our Dragon Medical license line. Although we are aggressively transitioning our U.S. client base to our DMO cloud solution, last quarter, we discussed how the international uptake of Dragon Medical would start with our on-premise products since these healthcare markets tend to be a bit behind the U.S. Most of the outperformance in our Dragon Medical license line came from Europe as we began to seed the market.

I believe we’re setting the stage for a strong adoption cycle, which is why we revised up our estimates in this division. Turning to Enterprise. The team had another strong quarter with some notable large customer wins including Kroger and the U.S. Postal Service as well as strong performance from our channel partner community, which includes Cisco, Genesis and Avaya, to name just a few.

Market demand and pipeline for our AI-powered omnichannel customer engagement solutions and services, which span digital, voice and security and biometrics, remains strong. In the quarter, we had numerous go live deployments for digital messaging and chat across large financial services, government, telecommunication and retail brands including Albertsons, Esurance and TeleCentro. Our voice and security solutions also had significant deployments including at Allied Irish bank, Charter, Deutsche Telekom, Lloyds and PayPal. We are very pleased with how our team overperformed in Q1, yet remind you that it is only the first quarter and Enterprise can be lumpy quarter to quarter.

We feel great about the full year and are reaffirming our previous guidance for Enterprise in 2019. As you’ll recall from my first earnings call with Nuance, I was quick to point out that I take achieving our financial obligations to our investors very seriously, so I’d rather err on being conservative rather than too aggressive. We are working hard to build credibility with all of you, and we will let our achievements and momentum of our business speak for itself. Turning to our Automotive business.

Our team had a solid quarter as we secured a number of new design wins including Audi, Daimler, Jaguar Land Rover and Hyundai, among others. You should think of these as new wins primarily as new lines or models within existing customers, given our expansive customer footprint. The energy and velocity behind this business was perhaps best exhibited last month at CES, where we showcased innovations like gaze detection, coupled with augmented reality, emotion analysis and siren detection. This was the first time Nuance had a significant presence on the CES floor and the timing could not have been better.

After more than 300 meetings with customers, partners, media, analysts and investors, the Nuance automotive team generated real industry excitement about where we’re headed. I’m appreciative of how this business is executing our multiyear plan, and I’m excited for how the upcoming spin will be able to unlock value. Giving this management team the ability to apportion resources without competing with our other businesses for investment dollars would be a huge benefit to this business. On that topic, the separation is on track for later this fiscal year, and we are well under way in the process of hiring a CEO, assembling a Board of Directors, carving out the assets and IP and finalizing the cross-licensing process.

Furthermore, we’ve assembled a dedicated internal team that has been exclusively focused on this important work without distraction to our other businesses and operations. And finally, Imaging. In its last quarter with Nuance, went out on a high note and a strong quarter. As you saw last week, we completed the Imaging sale roughly two months ahead of schedule.

We’ll be using approximately $300 million of the proceeds from the transaction valued at $400 million to pay down some of our higher cost to outstanding debt. This obviously has the nice effect of lowering some of our interest expense and improving our debt ratios. I am proud of the way the Imaging organization rose to the occasion to close out their last chapter at Nuance. I’m confident that this team will prosper, and I wish them the best for the future.

Overall, it was a great quarter for Nuance, and we’re just warming up. While we’re pleased with the recent results, we are even more excited about what lies ahead. We have a strong pipeline, new solutions, new markets and new opportunities. So looking at our Q1 performance, our work on capital allocation and the numerous tailwinds for the company, I think we are set up nicely for the remainder of the year.

As we’ve discussed in recent quarters, the thoughtful, comprehensive portfolio reviews and cost programs that we’ve completed will help define the future of the business. Reflected in the Q1 results, you saw that we have been able to accelerate some of our cost reduction programs, and importantly, give us the ability to also accelerate certain investment plans we laid out without reducing margins. We are on track and I’m very pleased with our progress. In addition, the market gave us an opportunity to buy back quite a bit of stock: 4.9 million shares in the quarter and another 1.2 million in January, at what we think is very attractive prices.

In my mind, it doing so demonstrates confidence in the business, and that we’re on a right path. Between the stock buybacks and the $300 million of debt we’ll be paying down shortly, you can see our disciplined approach to capital allocation is progressing nicely. With the positive dynamics in our business and what we’ve done with capital allocation, I’m pleased to say that for our continuing operations, we are raising our operating margin and EPS guidance and maintaining full-year revenue guidance. As I said last quarter, there will be some variability from quarter-to-quarter and our path to achieving our financial goals may not be exactly linear, but we feel really good about our plans and are executing in a way that makes me incredibly proud of the team.

I’ll turn the call over to Dan to spend a few minutes on the financials.

Dan TempestaChief Financial Officer

Thanks, Mark, and good afternoon. As Mark mentioned, we had a very strong first quarter, and overachieved our guidance metrics on both revenue and earnings per share. Before jumping into the results and guidance discussion, I want to spend a few moments on the reporting and presentation changes this quarter. First, as we discussed last quarter, effective October 1, 2018, we have adopted a new ASC 606 revenue recognition standard, giving the modified retrospective approach, and therefore, we are presenting, within our 10-Q and prepared remarks documents, both ASC 606 and 605 actual results.

Under this approach, we do not recapture historical financials for the provisions of ASC 606. Given this lack of comparability, as I highlighted at the beginning of the fiscal year, our primary approach to evaluating the business results and guidance in fiscal-year 2019 will be on an ASC 605 basis. We will continue to provide ASC 606 guidance only for revenue and EPS, and that will only be on an annual basis. The remainder of my results and guidance discussion today will be on an ASC 605 non-GAAP basis.

Consistent with our recommendation last quarter, we encouraged sell-side analysts to submit ASC 605 estimates for consensus purposes. Second, on February 1, we closed the sale of the Imaging business to Kofax, therefore, we are presenting our Q1 2019 results on a continuing and discontinued operations basis, and have restated the prior year financial results to reflect this change. However, since we previously provided guidance on a combined basis, I will briefly highlight those combined results against our prior guidance. I will then transition the discussion to a continuing operations basis only and explain the key drivers of our results.

In the quarter, we delivered non-GAAP revenue, combined in non-GAAP revenue of $516.3 million, up 1% on both and as reported and organic growth basis. This exceeded the high-end of our revenue guidance range, driven by overperformance in Enterprise licensing and on-demand cloud offerings, as well as strong Imaging results. Dragon Medical and Automotive also had very strong quarters — quarter. We delivered non-GAAP diluted earnings per share of $0.34, also above the high end of our guidance range, due to the strong revenues, a favorable Healthcare revenue mix and disciplined expense management in the quarter.

You will see the combined results compared to our previous guidance in a table on Page 5 of our prepared remarks document. Turning to continuing operations. Our Q1 2019 non-GAAP revenues totaled $465.7 million, up 2% versus last year on an organic basis, led by strong performance in Dragon Medical cloud, Automotive and Enterprise. This was offset in part by the expected declines in EHR implementation services, back-end transcription services and the continued wind down of our Devices and SRS businesses.

Before discussing margin results for the continuing operations, I want to provide some color on the Imaging segment’s historical margin profile, so that you can better appreciate how the removal of this business will impact our continuing operations margins. The Imaging business has historically enjoyed gross margins higher than the company average due to the revenue mix toward higher margin licensing and maintenance revenues. However, operating margins more recently were closely aligned to the company average due to the higher Imaging operating expenses. In Q1 2019, non-GAAP gross margins from continuing operation was 62.5%, up 360 basis points compared to prior year.

We benefited from higher revenues in the improved revenue mix, particularly in Healthcare, where there was a shift from Professional Services revenue toward higher-margin cloud and License revenue. Non-GAAP operating margin from continuing operations for Q1 2019 was 28.5%, up 460 basis points from a year ago. We achieved these results while absorbing $4 million of stranded costs. This strong performance was due to the gross margin dynamics previously noted as well as disciplined expense management.

Since I have mentioned stranded costs as part of the Imaging sale, let me spend a few minutes on that topic. Overall, we expect stranded costs will be approximately $12 million from the Imaging sale bid through the end of the fiscal year. These costs primarily relate to our G&A functions and will be reflected in the operating section of the income statement. The cost will be offset by approximately $6 million in fees we expect to receive related to providing transition services to Kofax.

These fees will be recorded within other income, which is below the operating section of the income statement. What that means is that the full value of the stranded costs will burden our operating margins without the offsetting benefit of the TSA fees. However, the fees received will be reflected within our net income, earnings per share and cash flows. I will come back to this topic when I discuss guidance for the full year.

One last point on stranded costs. The majority of our stranded costs reside within G&A. However, there are some shared costs that reside in other operating areas such as sales and marketing. The reallocation of these non-G&A costs to the continuing operations has a small impact to our historic segment margins.

Please see our prepared remarks document for a reconciliation of these modest changes. As Mark mentioned earlier, we remain committed to our capital allocation approach, and we are seeing the positive impacts on our earnings. In the first quarter of fiscal 2019, we repurchased 4.9 million shares of common stock at an average price of $15.36 per share. From the beginning of the fiscal year through January 31, the company has repurchased a total of 6.1 million shares for an aggregate consideration of $91.3 million.

This has a noticeable impact on our shares outstanding for the remainder of the year. As it relates to debt, with the close of the Imaging sale, we have notified our bondholders of our intent to pay down all outstanding amounts of our five and three-eights bonds due in 2020, at par for $300 million. Payment is expected to be made early next month and will reduce the annual cash interest expense by approximately $16.1 million. I am also very pleased with our current net debt leverage ratio at 3.2 times as of December 31.

On a pro forma basis, giving effect to the planned debt pay down, the company’s net debt leverage ratio would have been approximately 2.8 times, representing significant progress in the last 12 months. Let’s now discuss the full-year continuing operation guidance. As I mentioned earlier, this guidance will match our primary reporting approach to managing the business, which will be on an ASC 605 continuing operations basis. Furthermore, as I discuss each of the guidance measures, I will provide color on the impacts of excluding discontinued operations, the effects of stranded costs as well as any updates we are seeing in our continuing operations.

We have also provided guidance tables in the prepared remarks document that clearly lay out a bridge for each of the impacts I’m about to discuss. Lastly, while we expect the Automotive spin to occur in Q4, we will continue to include the Automotive business within our full-year guidance until that transaction occurs. To begin on guidance, we forecast full-year non-GAAP revenue from continuing operations to be between $1.847 billion and $1.889 billion. This reflects no change to each of the segment revenue guidance ranges from 2019 but simply eliminates the projected Imaging revenues as a result of the sale.

For Healthcare, although we are maintaining our overall revenue range, we are updating the mix to reflect strength in our Dragon Medical cloud and Dragon Medical licenses sold internationally, offset by a corresponding reduction in EHR implementation services. This updated revenue guidance also gives us further confidence in our ARR range of $245 million to $255 million. These updates to our individual Healthcare lines are detailed in our prepared remarks document. In Enterprise, although we had a very strong first quarter, as Mark previously mentioned, we are maintaining our prior revenue guidance range for the year.

Turning to margins. Prior to the impact of discontinued operations, we expected gross margins to be approximately 63%. When accounting for the impact of discontinued operations and stranded costs, our gross margins declined by approximately 200 basis points, establishing the baseline for continuing operations gross margins of 61%. This reduction is primarily driven by the loss of Imaging license and maintenance revenues I referenced earlier.

However, due to the improved revenue mix in Healthcare and disciplined expense management, we are raising our continuing operations gross margins guidance by 100 basis points to 62%. Our Healthcare segment margins were previously guided to be approximately 34%, similar to 2018. After adjusting for the improved revenue mix and margin benefit and somewhat offset by the modest impact of stranded costs, we are raising our Healthcare segment margin guidance to a range of 34% to 36%. Our original 2019 operating margin guidance was in the range of 26% to 26.5%.

When accounting for the impact of discontinued operations and stranded costs, our operating margin declines by approximately 75 to 100 basis points, establishing the operating margin baseline for continuing operations of 25.25% to 25.5%. However, this is entirely offset by the operational benefits in our gross margin and our disciplined expense management. As a result, on a continuing operation basis, we are raising our operating margin guidance by 75 to 100 basis points to a range of 26% to 26.5%. Our full-year non-GAAP diluted earnings per share guidance was originally $1.19 to $1.27.

The affected disc ops and stranded costs reduced diluted earnings per share by $0.17 to $0.19, establishing continuing operation EPS baseline of $1.02 to $1.06. However, we are raising the earnings per share for continuing operations by $0.08 to $0.10 resulting from the operational improvements I laid out, plus the reduced net interest on the $300 million debt pay down, the expected transition service fees from Kofax and the effect of our share buyback activities. Combined, these factors drive our revised earnings per share guidance on a continuing operation basis up to a range of $1.10 to $1.18. This guidance does not assume any further share repurchases or debt pay down outside of what has already been discussed.

Our previous 2019 guidance for cash flows from operations was between $390 million and $435 million. After excluding the operating cash flows we lose from the Imaging business, offset by the cash flow benefits we expect from the operating improvements in interest expense savings, we now expect cash flows from operations guidance to be in the range of $380 million to $425 million, resulting in a reduction to the range of just $10 million. We are also providing our updated cash balance expectations as of September 30, 2019 in the prepared remarks document, which include the effect of the share repurchases through January 31 as well as the planned debt pay down. For Q2 2019, we expect non-GAAP continuing operations revenue between $439 million and $453 million.

And we expect non-GAAP diluted earnings per share to be between $0.24 and $0.27. In closing, let me echo Mark’s comments about our progress in the past quarter. We are moving forward on many fronts and our team is motivated and focused on our near and long-term goals. I am pleased by our accomplishments, and I look forward to updating everyone throughout the year.

With that, let me turn the call over to the operator to begin the Q&A session. Operator?

Questions and Answers:


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

Saket KaliaBarclays — Analyst

Hi, guys. Thanks for taking my questions here. A lot to get through here, but maybe we’ll start with you first, Mark. And maybe a question on the Healthcare business.

Nice to see that position on the outlook and the outlook stay the same. I think we also saw within that a little bit of a shift away from the lower margin services revenue toward some of the higher margin Dragon Medical cloud. And so the question is, can you talk about what’s maybe driving that? Whether that’s something that, we are driving the changes in the sales force? Or is it something that maybe the market is really dictating?

Mark BenjaminChief Executive Officer

Yes. So thanks for the question, Saket. Good to hear from you. So certainly, the shift in revenue for the Healthcare business, it actually is quite favorable for us as we look at our cloud business and all the characteristics that come with that business and, so we’re pleased to have the ability to raise the full year there.

And the softness we’re seeing is really around our EHR implementation services and there’s really no shift in our selling of those services. It’s really about the broader market, and if there are — or any go lives largely around Epic installations that we handled the implementation for. So that business had an incredibly strong second quarter last year followed by a third quarter. And if you remember last year, we were talking about that strength which we viewed as somewhat abnormal.

And we kind of normalized the business this year. And we’re seeing a little bit of softness. So we thought it was prudent to really kind of curtail what we thought the business could do and get it more in line with historic levels, but it’s a shift — it’s a revenue mix, rather, Saket, that we actually like the outcome of. These — also these installation services, they’re not really connected to our Dragon Medical cloud offerings.

These are real true EHR implementations that ultimately benefited us in relationships, but they’re not critical to our business going forward.

Saket KaliaBarclays — Analyst

Yes, absolutely. I think that shift makes a ton of sense for the business. Maybe for my follow-up for you, Dan. I appreciate the accounting of the stranded costs and some of the below-the-line impact from the transition services agreements.

But perhaps thinking looking beyond fiscal ’19, maybe just near-term, maybe first, how do you think about those transition services sort of lasting? And then even beyond that longer term, how do you think about those stranded costs inside of the overall Nuance, if that makes sense?

Dan TempestaChief Financial Officer

Yes, it’s a very good question. Contractually, those services go out for some time, but I’d say we should really think about them lasting anywhere from six to 12 months, I think. Kofax is motivated to move off those services as well. So some of it will go into next fiscal year, but I think the majority will start to wind down.

As far as stranded costs are concerned, listen, we’re really focused on it. As the services wind down, we need to move those costs out of the business. We need to really protect our operating margins. We’re very focused on that.

As we take down the costs, not every cost will be — there’ll be other places where some of the costs come out as well. So again, really focused on that $12 million that you see in the P&L.

Saket KaliaBarclays — Analyst

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


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

Daniel IvesWedbush Securities — Analyst

Yes. Thanks. So maybe you could talk about, so far what you’ve seen on the auto spinoffs, I mean, you still have positives from CES, but maybe if you just talk about some changes, pushing down some of the spending per customers, partners. Start there.

Mark BenjaminChief Executive Officer

Yes, sure, Dan. It’s Mark. CES really gave us a chance, and me a chance to spend significant time with our customers and partners. I think those as the, are the namebrand OEMs and manufacturers that we all know.

And I had several discussions with them as well as the large suppliers. And I think it’s exciting that they view the business on a stand-alone as staying really focused on the way it goes to market as truly a white label offering, but now we’ll also benefit from greater focus, and a management team that really has less competing priorities that don’t necessarily relate to the auto industry. So the management team for our Auto business is also well-positioned for the spin. We’ve also made very good progress around — in the market for a new CEO, preparing a new Board of Directors, all the necessary filings, as well as all the internal work here around carving out the business for a stand up.

And then relative to IP, cross-licensing agreements and other related matters. So we’re in a very good position. We’re executing as scheduled on all facets of the spin. And the market, it really is — my feeling after leaving CES, after literally those hundreds of meetings I referenced, was quite positive.

Daniel IvesWedbush Securities — Analyst

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

Mark BenjaminChief Executive Officer

Yes, I mean, I think the story continues. I mean, the Healthcare industry at the acute ambulatory levels is under massive pressure. It begins with physician fatigue and burnout and the required administration levels of the clinician today versus seeing patients. And really, measured outcomes and impacts on error rates, not to mention the pressure on cost and reimbursements because we know that reimbursements come down unless the actual care is captured accurately.

So there still remains a ton of pressure in the system. And our solution really continues to improve that environment in meaningful ways across all of those aspects. So I would say we continue to really enjoy a market-leading position. Our solution now that had transitioned to the cloud, with Dragon Medical One, really provide the ability to lay in more AI into the solutions, which ultimately give physicians back more time, improve quality of care, make the solution more valuable and it really gives us the ability to extend the services beyond what we’re just doing today.

So the CEOs of large hospital networks and IDNs and even at the mid-end of the market, they are looking for help. And we are really positioned in a very good spot to be able to offer that.

Daniel IvesWedbush Securities — Analyst



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

Jeff Van RheeCraig-Hallum Capital Group — Analyst

Great. Thanks. Congrats on the quarter guys, a lot of moving parts to be sure, but just a couple of sort of deeper dives, particularly on the Healthcare side. And you called out, Mark, the strength in the near international around Dragon, and particularly on the licensing sides.

Can you maybe just talk about the dynamics of that international expansion? A lot of greenfield there, it sounds like, from your comments, it’s the way that customers want to consume this on a fund basis. Do you envision this multiple use of license amendment at some point on the future and start to get to cloud? Or just talk about the demand and the method of delivery there internationally, if you would.

Mark BenjaminChief Executive Officer

Yes, sure Jeff. Well, first of all, we’re incredibly excited about the international expansion, and if you remember, I spoke on the last call about redoubling our adjustable market and this was one of the, essentially, tools to do that. We’re in a few different countries today that are largely still license-based, on-prem based, and we are standing up our cloud solution and think of it as three or four different countries in Europe, in Australia and in North America, we’re essentially all cloud in the U.S. and Canada, so.

We’ll continue to go to market. We think strategically it is important throughout Europe, in key markets to sell our Dragon Medical Solution as a license where the market is still only a license market. And ultimately, as you know, we have a very good ability to flip them over to our cloud solution. And in some cases, Jeff, we’re still not deployed on a cloud-enabled solution in some countries.

The strength in the quarter came right out of Europe, on that Dragon Medical license line. And we see a very strong pipeline to continue. And our customers, when they sign up with Nuance, they stay for many years, so we think we have a great opportunity for the long-term, to go in on devices, convert to the cloud, as we market and as our solutions are prepared.

Jeff Van RheeCraig-Hallum Capital Group — Analyst

And just to be clear, I mean obviously, you posted good numbers there, but compared to your expectations coming into the quarter, in the end, particularly, are performed on Dragon?

Mark BenjaminChief Executive Officer

Yes. It was a strong quarter for EMEA.

Jeff Van RheeCraig-Hallum Capital Group — Analyst

OK. And then on the Enterprise side, can you just talk a bit about kind of the demand environment, segmented kind of down the middle, if you would. Omnichannel, digital channels on one side, sort of legacy on other. It sounds like you called out some on-prem licenses with some of your historical Cisco value type partners.

Just talk about the two sides of the business, both what you saw on the legacy side this quarter that drove the over-agit and then just spend a minute just talking about what you’re seeing on the omni channel side as well.

Mark BenjaminChief Executive Officer

Sure. Well, we actually saw strength in the quarter across all lines of — or lines of business, if you will, with Enterprise. We had a very good quarter with our voice and security solutions around biometrics. We continue to be the de facto standard in IVR, in the industry.

And again, our digital omnichannel solution’s really resonating end-to-end in the market. So it’s really the third quarter in a row so, that this business has really performed quite nicely. And we’re thrilled with the performance. We have great confidence in the full year for the business and — I’d say we’re doing well across the product suite there.

The competition remains the same. We continue to do well relative to our competitors. Our channel partners continue to, I think, go-to-market with us very well. And we had a good quarter in some of the cloud and on-demand solutions in Enterprise, too.

And Jeff, as you know, the business, some of those solutions that are “on-demand” have to do with outbound and perhaps if an airline has weather impacting delays or schools closing or late openings, that tends to, if you will, ring the register with our on-demand solution, so. We had a very nice quarter, it’s a great way to start the year for that business.

Jeff Van RheeCraig-Hallum Capital Group — Analyst

And just one last follow-up there. On the legacy, the strong premise license performance. Just the pipeline there, how does that, what’s the outlook there? How does the pipeline look for similar strength?

Mark BenjaminChief Executive Officer

You’re still talking about the, I’m sorry, the Enterprise business?

Jeff Van RheeCraig-Hallum Capital Group — Analyst

The Enterprise premise license business.

Mark BenjaminChief Executive Officer

Yes. It continues to be very good. When we build the full-year plans, we look at the pipeline, we look at what’s in our backlogs and we certainly got off to a strong start, the team feels really good about the year and what’s in store, so very positive.

Jeff Van RheeCraig-Hallum Capital Group — Analyst

Got it. Good. Thanks so much.

Mark BenjaminChief Executive Officer

All right, Jeff. Thanks.


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

Sanjit SinghMorgan Stanley — Analyst

Hi. And thank you for taking the questions and congrats to the team on the progress side thus far. I had a question on the Automotive spinoff [Inaudible]. And maybe Dan, from initial thoughts on how we’re thinking about the assets allocation toward Automotive in terms of do we think about some of the debt moving on to the Automotive business.

Any thoughts there?

Mark BenjaminChief Executive Officer

Sure. We’ve talked about this. This is something we are currently looking into, of course, with our advisors. Probably as we get further into the year, we’ll give you some information more on that.

But I think for planning purposes, there’s definitely going to be some debt on the books of Automotive. Early planning would suggest we think debt leverage neutral on a combined basis. So whatever our leverage is at Nuance, if you lever up Auto to allow for that leverage neutral, that’s the right way to think about it now. But as we make progress, we’ll talk more about it.

Sanjit SinghMorgan Stanley — Analyst

I appreciate those initial thoughts. That’s very helpful. And then maybe on the topic of margins. I think the margin performance this quarter was the best I’ve seen maybe in a couple of years, and it’s in terms of the improvement, and I know you would — you were very clear about some of the puts and takes going forward.

But in terms of the benefits, is the right way to interpret the margin benefit is just the fact that the Services business in Healthcare was down? Or are there more sort of durable, longer-lasting operational improvements that are guiding the business?

Dan TempestaChief Financial Officer

It’s a little bit of both. We certainly had a good mix quarter across the board. The Healthcare mix is improving, as Mark talked about. Enterprise had a really good quarter and it came with a very positive mix.

So that certainly contributed. When we score some large licensing that comes with very good margins and that helped. And then yes, across the board, of course, we have a savings program and expense management that’s always under way. We made really good progress in expense management this quarter, faster than we were expecting.

So that also contributed to the higher margins. But that’s now allowing us to accelerate our investments in the sort of the five or six growth areas that we talked about. So we’re going to get on with that even earlier than we expected.

Mark BenjaminChief Executive Officer

Yes, Andrew, this is Mark. I would just echo Dan’s comments. I mean, the revenue mix in Healthcare is really a great outcome because the stronger DMO revenues, obviously, that becomes permanent. So those revenues, now on the books have higher margin.

As far as the cost programs and expense management, we’re able to really bridge the gaps, if you will, of obviously, the reset business after disc ops, to now really raise and get back to, in some cases, it’s an amazing outcome to really, to be able to get back to those operating margins that we plan for the year, absent our Imaging business. So I’d say that we’re making significant investments back into the business, while managing expenses, running the business for the future with investments and really having the good outcomes of revenue mix. So as Dan said, it’s a combination of all of those things, but it, from my view, it’s a very good outcome and something I’m really proud of the team.

Sanjit SinghMorgan Stanley — Analyst

Thank you for the color there. And maybe one last one that I’ll squeeze in. In terms of ARR, I think that is a very decent metric for us to think about in terms of the Healthcare business. I think the additional metric’s going to be helpful in terms of driving the long-term on cash flow within Healthcare, if you get a sense of the renewal rates that you’re seeing on that ARR.

Is there any way to characterize what you’re seeing, and what should we think about as mid-80, 90%-plus, any way to get a sense of how the probability of those in recurring revenues being renewed every year.

Dan TempestaChief Financial Officer

Yes, great question, Sanjit, this is Dan. So recall that we really just started the DMO journey, the Dragon cloud journey in 2016. So we haven’t really hit any meaningful renewal cycles yet. That’s coming probably in the next year or two.

But if the Dragon Medical maintenance and support is any indication, then we’re expecting very, very high renewal rates, so. And the early signs are suggesting that is true.

Mark BenjaminChief Executive Officer

Yes, and that’s exactly right. And I also, I don’t think we’ll be susceptible to a large renewal cycle just given the growth rate of the business that’s taking place. So even as the business gets bigger on Dragon cloud, you see the 15% growth rates in the business. So these new sales, if you will, new customers, new conversions of the base from our on-prem as well as the HIM conversions, those get layered in, in multiple year agreements that renew at different times.

So we would expect a very high retention rate as a percentage of revenues when we begin to start to see renewals, I’d say, as Dan mentioned.

Sanjit SinghMorgan Stanley — Analyst

Excellent. Thank you for the answers.


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

Shaul EyalOppenheimer Holdings — Analyst

Thank you. Good afternoon, gentlemen. Congrats on results and the ongoing consistent execution. Mark, I want to go back to the international Healthcare expansion, the way you’re speaking on this is a great development.

I know you’ve been talking about it in the prior quarter. I think we are beginning to see that unfolding. I know it’s a tricky one, and I know you’re just beginning to work on that opportunity, but how should we think about the TAM, the opportunity, this addressable market opportunity that you might be seeing out there. Longer term, could that be equal to what we have seen over the course of the past few decades within the U.S.? I think we all have that numbers on the back front.

And also, is it an upgrade opportunity? Is it a displacement opportunity? What have the European Union’s been utilizing so far? Thank you for that.

Mark BenjaminChief Executive Officer

Sure, sure. Thanks, Shaul, for the question. And yes, we do see this as essentially a doubling of the addressable market as far as relative number of physicians to sell our services to. So think of that as, we’ve used in the past, 925,000 physicians in North America.

Think of that as essentially a similar number to, throughout Europe and some of our international markets beyond Europe, so we are as excited as you, and we think there is great opportunity. There is technology in the markets there, but less around broad adoption of EHRs which is really where we get embedded into the solution and we become super critical to the workflow. So I’d say the value proposition today in the markets is just beginning because it will move truly just from light transcription and voice technology to graded embedded workflow technology as the EHRs become mainstream. And we’re seeing the beginning signs of that.

We have a business that’s doing well in the U.K. We’re seeding a few other countries in Europe, as well as Australia. So we think that this is the very early innings of that adoption cycle for us. Now the payer systems are quite different country by country and region by region, but the fact is, the value proposition to the physician and all the clinicians is really the same.

And that, the cost burden, the fatigue burden, the administrative burden and quality aspects of what we provide is really the value proposition going forward.

Shaul EyalOppenheimer Holdings — Analyst

Got it, got it. Understood. And thank you for that elaboration. Dan, thank you for the discussion on the debt front, and I think as it relates to the net debt analysis.

I think as you’ve mentioned, there are around, let’s say, the three times, give or take. Even hypothetically or maybe strategically, would you be willing, down the road, to go back higher if needed, if there’s a strategic opportunity, whether on the Healthcare front, whether on the Enterprise front, will it be something that you might be considering down the road? Or the levels that you’ve indicated are pretty much the ones that you’re seeing as the optimal ones in the near to mid-future.

Dan TempestaChief Financial Officer

Hi, Shaul. Yes, that’s a good question. The great news about our financials is that we generate a tremendous amount of cash flow, and that just gives us the availability for options like that if we wanted. We’ve been focused on taking the debt down.

When we were up at four times gross leverage, and even more, that was a fine level for us to be at. It’s a comfortable level, so if there was something that was really strategic and really important to do, we could certainly go back there. But right now, we’re focused on this current capital allocation approach, and it’s going well for us.

Mark BenjaminChief Executive Officer

Yes, Shaul, this is Mark. So I think Dan answered it perfectly, and like you’d expect a CFO to answer it. But I would say, he’s absolutely right. As our net leverage comes down into the high 2s and our portfolio review is completed and as we really emerge out of these programs, we would likely be back in the market looking for the right type of opportunities for our business.

And as we deemphasize that for the last call near 12 months. And I don’t want to suggest we’re going to get back to a routine here that was once practiced, but we will also be very good stewards of our capital. And that’s what you see us practicing today and we’ll have the same measuring stick, if you will, as we look to deploy capital in an M&A environment too.

Shaul EyalOppenheimer Holdings — Analyst

Got it. Now this is great feedback, and thanks for that. And then maybe just really, if I may squeeze in, I believe I know the answer but I just want to hear it coming out from you guys and I think results would have indicated, but any impact from the government shutdown? Anything that you might have been seeing in recent weeks or recent months?

Dan TempestaChief Financial Officer

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

Shaul EyalOppenheimer Holdings — Analyst

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

Dan TempestaChief Financial Officer

All right, Shaul. Thank you.


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

Tom RoderickStifel Financial Corp — Analyst

Hi, gentlemen. Thanks for taking my questions. So I wanted to kind of hit the Enterprise segment here and think about it in two ways: number one, just in terms of some of the innovation efforts you’re making and in particular, I’d love to hear a little bit more about customer response to voice biometrics, what that might be doing from a vertical perspective and a demand perspective on the Enterprise side. And then if I switch gears, the second part of that equation is, thinking about where — while you’re innovating, where there is an opportunity to create some efficiencies in the model on the Enterprise side and think about how to expand those margins.

So if I totally look at the first quarter, it looks like 32% segment margin up, I think from where last year was. But it’s also to guiding the full year to about that 29% level, if I got it right on a 605 basis. So maybe can you help me to sort of think through what the demand level for new innovation looks like? Where you want to continue to innovate? And how we think about the segment margin structure for this year and where the dollars go back into. Thanks.

Dan TempestaChief Financial Officer

Sure. So hey, thanks for the question. Yes, I mean, the demand in pipeline throughout Enterprise is really focused around the AI solutions relative to customer engagement. I mean that, that really is, I think, at the headline, the right way to think about this business.

When we say omnichannel, we’re talking about how it spans the digital voice spectrum of modality, if you will, like the different user interfaces. Certainly, voice security and voice biometrics is a very important part of those discussions because the way we’re embedding our voice bio solutions comp is really in a — it can also be very much in a passive way within the call center of our customers. So I bet just one example of AI really being laid into the solution. I would also say that virtual assistants, within the call centers, that’s not a new business for us.

You have heard us probably talk about Nina in the past, well before my arrival. We’re starting to see, I’d say, a renewed momentum around virtual assistants in customer engagement. The capabilities and what we harvest around the technology is really emerging. In fact, we had our user conference taking place this week in Las Vegas, where we’ve rolled out a new solution we call Pathfinder.

And you may have seen it actually in the press this week because it got remarkable coverage. And it’s really relative to highly specialized domains around virtual assistants that we bring to market. And that, we’re now able to take voice conversational, voice interactions to make virtual assistants smarter with our Pathfinder solution, so. By the way, it’s just one example of, like the, I’d say the thirst that our customers have in the end of the market we play for our technology, all based on our AI solutions, conversational AI solutions.

So we’re seeing it throughout the telcos, we’re seeing it throughout financial institutions. We’re seeing it in large retail environments where customer authentication and engagement is critical. And I think I also got a little lucky, timing-wise, with joining Nuance really just as, I think voice started to take off in a new and meaningful way to Nuance, serving in Enterprise and Healthcare.

Tom RoderickStifel Financial Corp — Analyst

Yes. And then maybe just a quick follow-up on that. I’ll throw this one at you, Dan, just in terms of the profit segment for Enterprise. It bounced around profitability last year a little bit.

Can you just remind us of anything seasonal from either a cost perspective or a revenue recognition perspective that would cause that segment margin to jump around as we think about our own models?

Dan TempestaChief Financial Officer

Sure. It is always going to jump around, it is not going to be — it’s going to see that type of pattern. It’s because in quarters where you have really strong licensing, the margins go up. And then when it’s more than average level, it’ll kind of level back down, so that sort of upper 20s is the right landing point for it — on a 12-month period, but it could have fluctuations in period to period.

And I think, just getting back to your question around how do you improve the margins. I think that as our digital channel cloud, in some of our on-demand offerings, get more mature and you see more activity running through those models, over time, we would really like to see our cloud margins go up, and that should move the average up as well.

Tom RoderickStifel Financial Corp — Analyst

Excellent. Really helpful. Thank you, guys.

Dan TempestaChief Financial Officer

Thank you.


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

Mark BenjaminChief Executive Officer

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


[Operator signoff]

Duration: 60 minutes

Call Participants:

Richard Mack — Senior Vice president, Corporate Marketing and Communications

Mark Benjamin — Chief Executive Officer

Dan Tempesta — Chief Financial Officer

Saket Kalia — Barclays — Analyst

Daniel Ives — Wedbush Securities — Analyst

Jeff Van Rhee — Craig-Hallum Capital Group — Analyst

Sanjit Singh — Morgan Stanley — Analyst

Shaul Eyal — Oppenheimer Holdings — Analyst

Tom Roderick — Stifel Financial Corp — Analyst

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