Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Why You Should Be Worried About Nuance Communications

Nuance Communications' (NASDAQ: NUAN  ) recent earnings results likely left investors worried about its ability to successfully navigate a difficult revenue transition. The company's fiscal 2014 full-year earnings guidance fell significantly short of analyst expectations, which prompted the stock to sell off to multiyear lows. Unfortunately, there are plenty of reasons why Nuance may have a difficult future ahead.

Getting up to speed
Nuance has been dealing with a shift in the way it's being compensated by its customers, which has accelerated in recent years. Instead of licensing out its voice recognition technology for a predetermined period and being paid up-front, a growing base of customers are opting for on-demand (or usage-based) terms in which Nuance is only compensated when its cloud-based services are actually being used by the customer. This transition has put near-term pressure on Nuance's revenue streams, but the hope is that it will ultimately improve revenue predictability. Despite these headwinds, Nuance still expects its fiscal 2014 revenue will increase by 6% to 10% over fiscal 2013 results.

A double-edged sword
On one hand, transitioning to a usage-based service model invites the possibility of significant revenue upside for Nuance, assuming its products become more in demand with each passing year. On the other, an on-demand service model assumes that its services will increase in the future, which isn't even close to guaranteed.

Currently, it remains unclear whether this shift will actually benefit Nuance's business over the long-term because Nuance's estimated three year on-demand total contract value has fallen over the last two quarters. You would think that with more customers transitioning to an on-demand service model that Nuance's total on-demand contract value would be steadily rising.

Fiscal Quarter

Estimated 3-Year Total Value of On-Demand Contracts (millions)

Q4 2012


Q1 2013


Q2 2013


Q3 2013


Q4 2013


 Source: Nuance Communications.

Part of the problem
Given the current trajectory of worldwide smartphone adoption, it's surprising to learn that Nuance isn't expecting to organically grow its mobile phone revenue over the next year. After all, one of Nuance's biggest claims to fame is that it powers the voice recognition technology behind Apple's Siri and many other mobile voice-recognition engines. Considering Nuance's entire mobile and consumer segment, which includes smartphones, accounted for about 25% of Nuance's adjusted revenue last quarter, it's possible this lack of growth could be dragging down the total future on-demand contract value.

The other problem
Nuance has acknowledged that the shift to from up-front revenue to on-demand revenue has put a drag on operating profits. Last quarter, Nuance's on-demand revenue increased by about 9% year over year, growing to represent 32% of the company's total revenue. At the same time, its operating profit margin declined by 11% year over year to 32%, which was partially driven by the increase in on-demand revenue. At the end of the day, if the company wants to maintain a stable level of profitability as it goes through this potentially long-winded revenue transition, it will have to make up for the profitability shortfall with increases in usage from its on-demand customers.

What's more, with only 32% of Nuance's revenue coming from on-demand sources, it's quite possible that this revenue transition is only in its early stages, and investors may have to brace themselves for more profitability headwinds in the future.

Well, that was depressing
Theoretically, Nuance is one of those companies that offers tremendous promise in the future. It sits at the intersection of the next great leap in human productivity where we interact with our machines by using natural language. Unfortunately, the reality of the situation is that there are underlying issues with Nuance's business that's stopping it from realizing its full potential.

Perhaps Nuance will be able to work through these issues over the long-term, but it will certainly be a tall order and likely take a number of years. Realistically, if you're not willing to see this through at least two or three years, investing in Nuance's turnaround efforts isn't for you. This is going to require a high degree of patience and there's no guarantee the company will be able to escape the threat of shrinking margins and revenue headwinds.

What keeps Bill Gates up at night?
Interested in the next tech revolution? Then you'll need to learn about the radical technology shift some say forced the mighty Bill Gates into a premature retirement. Meanwhile, early in-the-know investors are already getting filthy rich off of it... by quietly investing in the three companies that control its fortune-making future. You've likely heard of one of them, but you've probably never heard of the other two... to find out what they are, click here to watch this shocking video presentation!

Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2748442, ~/Articles/ArticleHandler.aspx, 9/27/2016 3:10:01 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 5 hours ago Sponsored by:
DOW 18,094.83 -166.62 -0.91%
S&P 500 2,146.10 -18.59 -0.86%
NASD 5,257.49 -48.26 -0.91%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/26/2016 4:00 PM
NUAN $14.39 Down -0.17 -1.17%
Nuance Communicati… CAPS Rating: ****
AAPL $112.88 Up +0.17 +0.15%
Apple CAPS Rating: ****