This Industry Could Drive Nuance's Recovery

One key part of the rush toward artificial intelligence is making sure that automated systems can communicate easily and effectively with their human users. Nuance Communications (NASDAQ: NUAN) has a huge head start in voice recognition technology, and despite its successes in areas like medical transcription, the tech company knows that in order to sustain its competitive advantage, it needs to use its lead to push forward with groundbreaking technological innovations.

Coming into Wednesday's fiscal second-quarter financial report, Nuance investors wanted to see modest sales growth, and were prepared to accept slight declines on the bottom line. Nuance's numbers didn't quite meet even those low expectations, and the company's outlook wasn't entirely positive, either. But Nuance still has long-term promise as it finds new niche areas on which to focus its efforts.

Nuance suffers a slow quarter

Nuance's fiscal second-quarter results weren't able to sustain the positive momentum that the company generated three months ago. Adjusted revenue growth slowed to just 1%, with $518.3 million in sales roughly matching what most investors were looking to see. Adjusted net income fell 15% to $79.1 million, and the resulting adjusted earnings of $0.27 per share missed the consensus forecast among those following the stock by $0.01 per share.

Fundamentally, Nuance had high points and low points. Organic growth remained positive at 1%, but net new bookings dropped 8% to $376.6 million, reversing nice gains in recent quarters. Recurring revenue as a share of total sales once again dropped from year-ago levels, and that continued to raise concerns about whether Nuance's subscription business is performing as well as investors would like.

Performance across Nuance's segments was quite mixed. The automotive segment was the strongest from a sales standpoint with 12% organic top-line growth, although adjusted profit for the segment fell 1% from year-ago levels due largely to increased investment in research and development for the unit. Healthcare was also strong, seeing 8% organic sales gains and segment profit rise 5% on strong performance from professional services. Yet the often-strong enterprise segment saw profit fall 36% on an organic revenue decline of 8%, and the imaging segment had its bottom line drop by about a third as it posted an 8% drop in organic sales. The catch-all other segment was even weaker, as organic sales plunged nearly 30% and cost the unit about half its segment profit.

How can Nuance bounce back?

Newly appointed CEO Mark Benjamin had positive comments about his early experiences with the company: "In just a few weeks, my conviction about the potential of this company has been affirmed. There is real momentum in the core business, making it an exciting opportunity to step in at this pivotal moment."

The new CEO highlighted the need to look comprehensively at the entire Nuance services portfolio to identify the best available opportunities for growth.

The automotive sector looks like the best way to realize that vision. The company announced new design wins for its artificial intelligence offerings, as key customers include automakers BMW and Ford Motor. Nuance also showcased some of its next-generation automotive-interface and user-experience products with Mercedes-Benz manufacturer Daimler as well as Toyota. Security applications are also a potential growth area, with voice-based biometrics offering complementary protection with visual identity-verification products.

In the near term, though, Nuance cut its guidance. The company sees organic growth for the fiscal year rising in a range of just 2% to 4%, down a percentage point from its previous range. Nuance repeated its previous guidance on new bookings growth of between 5% and 7%, but adjusted revenue of $2.035 billion to $2.075 billion was $20 million less than previously projected, and adjusted earnings of $1.09 to $1.15 per share represented a $0.05 per-share drop from three months ago. Fiscal third-quarter projections also failed to match up to all the expectations of those following the stock.

Nuance shareholders weren't happy with that, and the stock plunged 13% in pre-market trading on Thursday following the Wednesday evening announcement. Automotive artificial intelligence products and services have a lot of potential to pull Nuance higher in the long run, but long-term investors will need to be patient in order to reap the benefits of the voice recognition specialist's expertise in the area.

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Dan Caplinger owns shares of Ford. The Motley Fool recommends Ford and Nuance Communications. The Motley Fool has a disclosure policy.