To boldly go .
Even though Nuance's (NASDAQ:NUAN) forte is speech and communication, the last conference call might have benefited from a universal translator.
It's not that investors were asked to interpret anything as difficult as Klingon, but the call did require some close attention to the definition of what earnings are and what they aren't. I like to see companies earn money the old-fashioned way in 2006 -- by GAAP definitions of profit. Nuance prefers pro forma, as if certain expenses are not counted.
Stardate -- fourth-quarter earnings 2006Nuance is evolving from a rather slow, stodgy document-scanning company into a 21st-century cutting-edge leader in speech recognition. If you have encountered a computerized, friendly, helpful voice, eerily reminiscent of the HAL 9000 in Stanley Kubrick's 2001, ready to guide you through a customer-service call or ticket reservation, you may have talked to a Nuance product. Nuance customers include Schwab (NASDAQ:SCHW), Verizon (NYSE:VZ), Bank of America (NYSE:BAC), and AMR's (NYSE:AMR) American Airlines.
A combination of nearly a billion dollars in acquisitions and a strong research-and-development program has helped Nuance grow. These things come with big price tags, however, and Nuance has felt the sting, with quarter after quarter of GAAP earnings losses.
Investors may be forgiven if they wonder just how much their company made this quarter. The conference call was a meteor shower of numbers, segment results, GAAP earnings, and non-GAAP earnings. Here are the results, with dollar figures in millions, except for per-share data.
Metric | Non-GAAP | GAAP |
|---|---|---|
Revenue | $133.20 | $128.20 |
Cost of Revenue | $38.10 | $43.20 |
Gross Income | $95.10 | $85.00 |
Gross Margin | 71.40% | 66.30% |
Net Income | $26.40 | ($6.70) |
Net Margins | 19.80% | (5.20%) |
Diluted EPS | $0.14 | ($0.04) |
By GAAP rules, Nuance lost $0.04 per diluted share. But non-GAAP numbers put a more positive spin on a losing quarter, by asking investors to ignore non-cash expenses and one-time events involved with acquisitions.
Let's look at the non-cash expenses Nuance deletes when calculating pro forma earnings, with figures again in millions.
Expense | Amount |
|---|---|
Amortization of Intangible Assets | $5.10 |
More Amortization of Intangible Assets | $6.80 |
Options Expense | $7.30 |
Non-Cash Interest | $1.10 |
Non-Cash Taxes | $5.40 |
Acquisition Cost | $3.40 |
Even though some "expenses" don't cost the company in cash at the time of the statement, they still represent investments in employee compensation, costs of acquiring businesses, and capital expenditures. Doesn't logic dictate that purchases and salaries should count as expenses against earnings? The Vulcan in me says yes.
I like to see a company that has a comfortable cushion of GAAP operating income to cover interest payments, with enough left over to generate positive net income and earnings per share. Nuance is not to that point yet. Again, in millions:
Metric | Amount |
|---|---|
GAAP Operating Income | $7.30 |
Interest Expense | $6.90 |
Other Expense | $0.40 |
Net Income Before Taxes | ($0.12) |
The company is unable to pay interest and other expenses from GAAP operating income and stay in the black, and that is part of the price of growth by acquisitions. Since GAAP earnings are the more commonly measured and reported numbers at financial sites, investors may be waiting to see the company begin to generate positive GAAP earnings before bidding up the shares into multibagger territory.
Nuance is closing in on profitability, and I am sure Mr. Spock would be impressed with its technology. The company has made good on its promise to keep R&D spending and other cash expenses in line this quarter, and keeping its word helped grow operating income. As the acquisitions become integrated and sales accelerate, the company may finally clear the important hurdle of GAAP positive earnings.
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Fool contributor Jean Graham does not own any of the stocks mentioned. The Motley Fool has a disclosure policy.
