Though Nuance Communications, Inc. (NUAN) remains relatively obscure in the investment world, most technology investors know that it powers the Siri voice recognition for the Apple (AAPL) iPhone. Typical of Apple suppliers, the associated stock performs poorly.
The company is a leading provider of voice and language solutions for businesses and consumers around the world. Its technologies, applications and services make the user experience more compelling by transforming the way people interact with devices and systems.
The company reported strong Q4 2012 results that handily beat estimates with earnings coming in ahead of the $0.48 analyst estimates by $0.03.
Q4 2012 Highlights
The company reported the following highlights for Q4:
- Nuance reported non-GAAP revenue of $490.1 million, which includes $21.3 million in revenue lost to accounting treatment in conjunction with acquisitions. Third quarter fiscal 2012 non-GAAP revenue grew 22.7% over non-GAAP revenue of $399.5 million in the same quarter last year.
- In the fourth quarter of fiscal 2012, Nuance reported non-GAAP net income of $164.9 million, or $0.51 per diluted share, compared to non-GAAP net income of $133.5 million, or $0.42 per diluted share, in the fourth quarter of fiscal 2011.
- Nuance's fourth quarter fiscal 2012 non-GAAP operating margin was 37.2%, up from 36.1% in the fourth quarter of fiscal 2011.
- Nuance reported cash flow from operations of $141.5 million in the fourth quarter of fiscal 2012, a 44.5% increase over $97.9 million in the fourth quarter of fiscal 2011.
With cash flow from operations up 45%, the company is showing strong execution. The company is benefiting from increased demand in mobile phones, automobiles, televisions and healthcare applications. Design wins and partnerships with Cerner (CERN), Intel (INTC) and Samsung will propel growth in the future.
The original guidance for Q4 was on the low end of expectations when the company reported back in August. Typical of the company lately, the actual numbers beat the high end of the $0.46 to $0.50 estimate. Now the company has provided the following guidance that disappointed the market:
- Nuance expects Q4 12 non-GAAP revenues to be in the range of $484 million to $500 million.
- Nuance expects 2013 non-GAAP EPS to be in the range of $0.33 to $0.37.
- Nuance expects Q4 12 non-GAAP revenues to be in the range of $2.17 billion to $2.22 billion.
- Nuance expects Q4 12 non-GAAP EPS to be in the range of $1.84 to $1.94.
While the Q1 revenue number is in line with analyst's numbers, the company guided considerably below earnings estimates of $0.41. Higher development costs are cutting into earnings as the company builds for 2014 revenue growth. Interestingly, the full year numbers were above expectations at that time of $1.84. Analysts have now raised guidance for 2013 to $1.89. The recent history suggests the numbers might hit $2 by the time fiscal 2013 is over. In fact, don't be surprised if Q1 doesn't end up around the previous target of $0.41.
While the company remains extremely profitable and cash flow positive, it has made numerous acquisitions via debt that place the balance sheet in an unfavorable situation. When fighting off the likes of Google and start-ups, the company will need a strong balance sheet.
Clearly the net debt of nearly $900M isn't an issue in the low interest rate environment, though the company might want to start showing that the strong cash flow will lead to reduced debt levels. The below chart shows the constant net debt position of the company:
The stock performance over the last 2 years remains disappointing considering the growth of voice-enabled services. The company just reported 32% cash flow growth for the last 12 months yet the stock is virtually flat.
Though the stock attempted to break out in September, it is now down to $21 again. This level is virtually where it traded for most of 2007 prior to the financial crisis and now forms a triple bottom.
2-Year Chart - Nuance Communications
A huge risk exists that Google (GOOG) has developed a better speech recognition service via Google Voice Search. While it isn't designed to be a virtual assistant such as Siri, the app has many examples where users think it provides a better voice search experience. Just last week, Slate pronounced Google Voice Search as the technology about to fulfill Apple's broken promise of talking to technology.
Farhad Manjoo sees both services as flawed, but Voice Search is the most useful in his opinion. According to him, the "Knowledge Graph" provides Google with a dynamic database that better keeps up with the flexible and constantly evolving world.
The stock is currently one of the cheapest technology companies around. With a cash flow run rate of around $600M based on Q3 and Q4 numbers, the stock trades at less than 11x those cash flows.
The stock also trades at less than 10x forward earnings estimates compared to a 5-year growth rate of 17% expected by analysts. Any time the growth rate exceeds the forward earnings multiple, the stock is considered cheap.
Using either metric, this hot technology company trades at a discount to the market showing that investors clearly place a huge discount on the stock due to the risks from Google.
After reading the earnings report and listening to the conference call, it is difficult to understand the reason for another earnings selloff. Sure the Q1 earnings guidance was low, but the stock is very cheap compared to full year guidance and expected 2014 growth.
The new products suggest the company has the ability for strong growth over the next few years. The demand for language-enhanced technologies appears to only be expanding in contrast to the stock price. The threat from Google remains real especially in the mobile sector that accounts for roughly 30% of revenue. The company has dominant positions in the Healthcare and Enterprise sectors that appear unlikely impacted by the current Google efforts.
The stock offers an attractive entry point right around these levels. If the stock breaks below $20 and definitely below $19, it will technically be broken. At these levels though, investors can make a gamble on the technology with a clear exit strategy.
Disclosure: I am long AAPL.
Additional disclosure: Please consult your investment advisor before making any investment decisions.