The last three months have been difficult for Nuance Communications (NUAN, Financial). The speech technology company's shares have declined almost 20% in the past three months. In addition, Nuance missed revenue estimates in the third quarter, and a decline in earnings didn't help its prospects either.
Setting itself up for improvements
However, Nuance is positioning itself for better times ahead, which is why it is changing its business model to focus on recurring revenue. This is a smart strategy, as the recurring revenue model will allow it to lock customers into its ecosystem. Moreover, the transition to a recurring revenue model is happening faster than expected.
This was apparent from the growth in bookings last quarter, with bookings growth rate for OnDemand contracts exceeding the aggregate bookings growth rate. The strength in bookings was a result of improving traction in Dragon Medical, Healthcare OnDemand, Enterprise OnDemand, MFP print solutions, and automotive products.
Positive effects of the transition
In addition, the positive effect of the rising recurring revenue models is also expected to result in increasing cash flow and deferred revenue. In fact, both deferred revenue and operating cash flows exceeded expectations last quarter, with 32% growth registered in the former and the latter representing 111% of non-GAAP net income.
Moreover, the transition is expected to add sustainability and predictability to the company’s future revenue streams, but it is impacting revenue growth in the short term. Nuance is aware of the challenges this shift toward recurring revenues is posing for near-term revenues, but it remains committed to expanding shareholder value during this transition as well.
As a result, the company is focusing on expense control techniques. Nuance plans to maintain these expense initiatives going forward, maintaining the objective of providing better margins along with the assurance of delivering future growth in its primary markets.
Also, Nuance has announced that it will exercise the call option on its 2027 convertible debentures. The redemption of these notes is expected to shorten its interest expense and minimize potential share dilution.
Nuance delivered year over year bookings growth of 17% to $547 million during the third quarter of fiscal 2014 . Total bookings increased 28% during the initial three quarters of the fiscal year, above the guidance, and there was a jump in the on-demand bookings growth rate as well.
Richard Davis of Canaccord reiterates a Buy rating with a price target of $22. He describes the stock as a “mystery” and is unaware of what actually is going inside the company.
Nuance's shift toward subscription does not necessitate the generation of a greater attach rate for modules which were unsold earlier, and this trend differentiates Nuance from Autodesk (ADSK, Financial) and Adobe (ADBE, Financial). Hence, Nuance is extremely inexpensive and the company is believed to be moving in the right direction with the stock expected to continue its upward movement. Therefore, the analyst maintains a BUY rating for the stock.
FBR Capital Markets maintain its market perform rating with the price target of 18 for Nuance stock. Although, Nuance illustrated solid growth on the key bookings number, management reduced the fiscal 2014 top and bottom line guidance, regardless of its continued focus on cost control.
The company’s net loss increased from $35 million, or 11 cents a share in the third quarter of 2013 to $54.2 million, or 17 cents a share, for the quarter ended June 30 2014.
Key statistics and conclusion
According to Yahoo Finance, the forward P/E of 14.37 signifies lower cost of the stock and is better than the industry’s average P/E of 33.36. The PEG ratio of 1.60 depicts slower growth as compared to the solid industry’s average of 0.98. The profit margin of 9.57% is disappointing and indicates no profit. The revenue per share and diluted EPS of 6.01 and 0.52, respectively, represent fall in the shareholder earnings. The quarterly revenue growth of 1.2% is minute and unsatisfactory when compared to the healthy industry’s average of 22%. However, the current ratio of 1.68 is fine and represents the robustness of the company’s balance sheet.
Finally, the investors are advised to cautiously invest into Nuance looking at the robust long term growth prospects as indicated by the CAGR for the next five years per annum of 9.67%, comparable to the industry’s average of 15.17% and expect promising returns in a long run.
