Nuance Communications, Inc. (NASDAQ:NUAN) remains a stock long on potential and short on performance. The company reported Q1 2013 results that largely missed estimates and provided disappointing guidance. The stock initially sold off 18% the following day and continues to get cheaper by the day after hitting 52-week lows on Tuesday. While the company continues to disappoint, the market ignores the valuation. A company that earns nearly $2 a year is still a company that generates strong profits regardless of its ability to meet estimates.
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 that is famous for being the technology behind the Siri product used by Apple (NASDAQ:AAPL) now infamously has a similar valuation metric to that customer.
Q1 2013 Highlights
The company reported the following highlights for Q1:
- Non-GAAP revenue of $492.4 million, which includes $30.1 million in revenue lost to accounting treatment in conjunction with acquisitions. First quarter fiscal 2013 non-GAAP revenue grew 28.9% over non-GAAP revenue of $382.0 million in the first quarter of fiscal 2012.
- Non-GAAP net income of $113.0 million, or $0.35 per diluted share, compared to non-GAAP net income of $108.5 million, or $0.34 per diluted share, in the first quarter of fiscal 2012.
- Non-GAAP operating margin was 29.2%, down from 32.5% in the first quarter of fiscal 2012.
- Cash flow from operations of $122.9 million in the first quarter of fiscal 2013, a 37.3% increase over $89.5 million in the first quarter of fiscal 2012. Nuance ended the first quarter of fiscal 2013 with a balance of cash and cash equivalents of $961.1 million.
The main issue investors have with the stock is the plunging margins. Costs appear to be rising faster than revenue making investors concerned that the competitive environment is starting to take a bite out of the results.
3 Main Issues
The company highlighted 3 major factors contributing to the weak results and disappointing guidance.
- Faster than expected erosion of healthcare on-demand transcription volumes due to implementation of EMR systems and Dragon medical.
- Environment in EMEA was weaker than expected across businesses other than handset and automotive.
- Slowdown in Windows based software sales, especially in the direct consumer business in conjunction with the Windows 8 replacement cycle.
Weakness in Europe isn't surprising considering the environment on that continent that existed during the last quarter of 2012. The conversion to new medical systems will hurt short-term, but towards year-end that sector will pick up with the products from the acquisitions. While the company didn't provide details, the ultimate concern has to be whether the company is hurt from the shift to tablets from PCs. Business that existed on PCs may not automatically shift to a Nuance product on all the new tablet versions.
For all the talk about the company missing Q1 estimates, Nuance actually hit the exact mid-point as originally provided below:
- Nuance expects Q1 2013 non-GAAP revenues to be in the range of $484 million to $500 million.
- Nuance expects Q1 2013 non-GAAP EPS to be in the range of $0.33 to $0.37.
The company provided the updated guidance for Q2:
- Nuance expects Q2 2013 non-GAAP revenues to be in the range of $500 million to $533 million.
- Nuance expects Q2 2013 non-GAAP EPS to be in the range of $0.36 to $0.45.
The trends toward usage-based pricing in mobile, term-licenses in healthcare and on-demand services in enterprise will have a tendency to elongate revenue cycles compared to the perpetual license model. As with the factors above, these issues are as much a shift in the product mix as any competitor problems.
A concern with the updated guidance was naturally the low-end estimate of only earning $0.36. The company was clear that the numbers are very dependent on whether several major deals close during Q2 or Q3. So Again the mix and timing of new products is as much at fault as anything else.
The stock performance over the last year has turned dismal. The stock peaked at around $31 in early February last year and now trades below $19. In fact, the trading on Tuesday sent the stock to new 52-week lows and places the current price on par with the average back in 2011. Long-term investors can't be happy after this last selloff.
As mentioned in the last article, the $19 level was a great buying opportunity, but if the stock didn't hold then it was technically broken and could head lower.
As the 2-year chart shows, Apple has easily outperformed Nuance even after its recent major selloff.
2-Year Chart - Nuance Communications
The stock remains one of the cheapest technology companies around. The slight cut of FY 2014 earnings forecasts from $2.11 to $2.05 has been completely over shadowed by a gigantic stock loss now approaching 25%. The forward P/E has now dropped to 9x estimates placing the valuation in line with Apple. Ironic considering the valuation in the market and possibly highlighting that investors see its results tied to that of the diminished customer going forward.
After reading the earnings report and listening to the conference call, it is difficult to understand the reason that investors continue to push the stock down. Sure the Q2 earnings guidance was a concern, especially at the lower end, but then again investors weren't paying up for the stock. Nuance is now 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 healthcare sector might be experiencing some turmoil, but the new products should turn the division around in the next couple of quarters.
While the stock offers an attractive valuation at these levels, the technicals suggest the stock might get cheaper by the day as it heads to previous lows around $17 before bottoming. At those levels though, investors should load up to invest in the technology with a clear growth trajectory over the next decade.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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