It's increasingly looking like getting business from Apple (Nasdaq:AAPL) is a mixed blessing for small-cap tech companies. While investors had been looking for Audience (Nasdaq:ADNC) to use its solid relationship with Apple (and Samsung) as a platform from which to build on its voice isolation/noise suppression technology, it now looks as though Apple has elected not to use the company's technology in the next iPhone. Not only does that news hammer the expected profit stream for 2013, it also calls into question the broader bullish thesis for the company's technology.
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Apple Elects Not to Flip the Switch
Audience has had a relationship with Apple for several years now, with the company selling processors and licensing IP to Apple that Apple then incorporated into its iPhones. Audience informed investors on Thursday evening that based on a lack of customary pre-launch discussions with Apple, they now believe that Apple will not activate their IP on the processor of the next iPhone. Although that won't have a devastating impact on 2013 revenue (maybe around 10%), that royalty stream was virtually pure profit, and so it will have a significant impact on earnings and cash flow.
The Central Question ("Why?") Has No Clear Answer
Of course, Apple being Apple, there hasn't been formal confirmation of this, nor any insight into why the company would make this decision. While I guess it's possible that the company elected to go with a competitor's technology (perhaps Qualcomm's (Nasdaq:QCOM) software-based approach), I don't think that's the case. Rather, I'd say there's probably a better chance that Apple thinks either that the iPhone 5 doesn't need any noise suppression assistance or it has developed its own proprietary technology/capabilities.
That uncertainty is likely to be a real problem. At this point, voice isolation/noise suppression technology has largely been seen as "nice to have" technology for high-end devices, but not essential. If it turns out that Apple, a company notably obsessed with the user experience, doesn't think this technology is necessary, that could make it quite a bit harder for Audience to sell other customers on its importance, to say nothing of broadening usage into follow-on markets like tablets, PCs and autos.
Not a Fatal Blow at This Point
Apple has been a significant customer for Audience for a while now, and losing that relationship has always been a risk factor. However, it's important to note that Apple was not Audience's only customer. The company also relies heavily on Samsung for revenue (over 40% in the last quarter), and that relationship seems to be secure. Likewise, the company has announced recent wins with HTC, Huawei and Google (Nasdaq:GOOG).
The question, though, is whether the company can replace the revenue (and profits) that the iPhone 5 would have represented. In the short run the answer is very clearly "no," but the company does have a good chunk of cash on the balance sheet and appears to have a technology lead over Qualcomm, Texas Instruments (Nasdaq:TXN), Cirrus Logic (Nasdaq:CRUS) and Fortemedia.
Arguably, the best hope for Audience is that user reviews of the iPhone 5 cite noise/voice quality as a problem and that Audience-users like Samsung gain share as a result. That could be a long shot, though, as I can't recall Apple ever being forced to backtrack like that in the relatively brief history of the iPhone.
The Bottom Line
A quick look at the balance sheet indicates about $5.50 per fully diluted share in cash, against a current price of $6.10 as of this writing. Clearly, then, the market expects the loss of this Apple business to utterly devastate Audience, and many analysts have slashed their target prices into the single digits. I understand the fear, and I don't wish to soft-peddle the risk to the business model and sentiment that this news represents. That said, giving the company almost no value at all for its technology seems like an extreme reaction. Audience management is going to have to work even harder to establish its technology now, but this is a name that I think is going to be worth watching once the initial selling frenzy lets up.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.