Cerence Inc. (NASDAQ:CRNC) Q2 2024 Earnings Call Transcript

Cerence Inc. (NASDAQ:CRNC) Q2 2024 Earnings Call Transcript May 9, 2024

Cerence Inc. misses on earnings expectations. Reported EPS is $-6.66226 EPS, expectations were $-0.23. CRNC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Romani [ph] and I will be your conference operator today. At this time, I would like to welcome everyone to Cerence Q2 2024 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Rich Yerganian, Vice President of Investor Relations. Please go ahead.

Rich Yerganian: Thank you. Welcome to Cerence’s second quarter full fiscal year 2024 conference call. Before we begin, I would like to remind you that this call may involve certain forward-looking statements. Any statements that are not statements of historical fact, including statements related to our expectations, estimates, assumptions, beliefs, outlook, strategy, goals, objectives, targets, and plans, should be considered to be forward-looking statements. Cerence makes no representations to update those statements after today. These statements are subject to risks and uncertainties which may cause actual results to differ materially from such statements, as described in our SEC filings, including the Form 8-K with the press release preceding today’s call, and our Form 10-K filed on November 29, 2023 and our most recent Form 10-Q.

In addition, the company may refer to certain non-GAAP measures, key performance indicators, and pro forma financial information during this call. Please refer to today’s press release for further details of the definitions, limitations, and uses of those measures, and reconciliations of non-GAAP measures to the closest GAAP equivalent. The press release is available in the IR section of our website. Joining me on today’s call are Stefan Ortmanns, CEO of Cerence, and Dan Tempesta, CFO of Cerence. As a reminder, the only authorized spokespeople for the company are Stefan, Dan, and me. Before handing the call over to Stefan, I would like to mention that we will be presenting at the Craig-Hallum Investor Conference on May 29, the Baird Global Consumer, Technology and Services conference on June 6, and the Wells Fargo Industrials Conference on June 12.

Now onto the call. Stefan?

Stefan Ortmanns: Thank you, Rich. Welcome, everyone, and thank you for joining us to discuss Cerence’s second quarter results and the outlook for the balance of the fiscal year. While Q2 delivered results better than planned or we emulated adjustments, the outlook for the full year has weakened since we last spoke. Over the next few minutes, I will update you on how we see the remainder of the fiscal year progressing, provide some comments on the multiyear plan we communicated last November, and then provide an update on the positive progress we have seen with our AI products strategy since CES. While second quarter revenue was above the high end of the range, we are bringing down the full year guidance by $40 million at the midpoint, which represents an approximately 11% reduction in revenue.

There are two primary reasons for bringing down the full year guidance. First, after receiving Q1 royalty reports and noticing some downward trends, we commenced a deep account by account review of our backlog, which concluded in April. As a result of this review, we determined that some customers production expectations are not materializing as reflected in our forecasts. Second, to a lesser extent, our business in the adjacent and IoT markets is developing slower than anticipated, so we have reduced their expected revenue contribution accordingly. In addition, we believe that we are being affected by a slowdown in auto production and delays in production starts with respect to some of our customers. The increasing complexity of automobiles has created substantial challenges for some of the OEMs, leading to delays before systems are qualified for a new program to launch.

These delays have a compounding effect as the benefits from the higher price per unit associated with newer programs are not being realized as expected and it is taking longer for these programs to reach high volume. We are certainly disappointed in lowering guidance for the full year. As of our last earnings call, we believe the path to deliver on our original guidance, but unfortunately the business is not materializing as expected. Also included in our second quarter results is a goodwill impairment charge of approximately $252 million. The combination of the decline in our stock price and the lower fiscal year 2024 outlook led us to a goodwill assessment resulting in an impairment charge. While this has an impact on our reported GAAP results, it is a non-cash event and does not affect the ongoing operating results of the company.

Moving forward, we are focused on transforming the company to be in a position to deliver on our Generative AI and large language model product roadmap and deliver improved financial results. We understand that our cost structure is not properly aligned with our near-term revenue outlook and we will be taking action to address this, while also making sure we have the right balance to drive the success of our NextGen AI platform currently in development. Our expectations are that the expense benefit from these activities will begin to accrue in fiscal year 2025 and we will update you on next quarter’s call. That said, the current dynamics in our industry create an environment in which it has become very difficult to forecast business levels beyond the next year with a high degree of confidence.

As such, drawing the multiyear plan provided to you last November. While the vast majority of our revenue in the next one to two years is expected to come from our backlog, it still depends on actual production levels and on platforms starting production relatively close to their forecasted date. We are working closely with our customers to get better alignment on these expectations, but in many cases it can still be a moving target. We do want to offer some insight into fiscal 2025. While we are not prepared to provide guidance, Dan will review a brief framework on certain aspects on fiscal year 25 revenue, and we will provide full guidance during our Q4 earnings call in November. Current business conditions aside, we are motivated by and excited about our Generative AI product roadmap and the reception these products have received from OEMs. Because these products are cloud centric, their revenue contribution will be taken as connected services is first booked into deferred revenue and then amortized into revenue over the subscription period.

This means in the short-term, any success of our new products will be insufficient to make up for the expected revenue shortfall resulting from the factors I outlined earlier in the call. I would like to give you a bit more detail about our long-term growth opportunities related to our product roadmap and progress. As previously discussed, we are taking a multilayered approach to leveraging the latest in Generative AI and large language model technology, innovations that we believe will be critical to our future success. We have made solid progress in validating that our products and roadmap resonate with our customers, including signing six contracts for our Generative AI products since CES, with the first customer going into production next month.

Importantly, because these solutions can be delivered via the cloud, they can be implemented into both, new production vehicles as well as cars already on the road. Beyond our current product set, we are in proof of concept with three major global automakers to advance our future AI computing platform, a single conversational interface that combines voice and touch and is being built to work seamlessly across applications. This new platform will be based on users preferences and situational context, and provide proactive and predictive tips and suggestions for action. This progress gives us conviction and validation that our products and services will remain highly relevant for our customers. As we continue to chart the course ahead we believe that our exclusive data set and deep relationships with our customers will continue to be true differentiators for Cerence.

As we progress through the second half of the fiscal year, we have prioritized several objectives in order to strengthen our position in our core automotive business. First, balance our cost structure in accordance with our current levels of business while still ensuring we can successfully deliver on our Gen AI roadmap and customer commitments. Second, release several Gen AI solutions into production with high end user satisfaction and third, convert the deals currently in the pipeline, including some win back opportunities. Before I turn the call over to Dan Tempesta, our new CFO, I would like to take a moment to introduce him. Dan joined us in mid-March and was previously CFO of Nuance. As such, he is very familiar and experienced with the auto business and our solutions.

With Dan’s track record of leadership and experience in the space, we are happy to have Dan on board at this important moment in Cerence’s journey. I would also like to take the opportunity to thank Tom Beaudoin for his contributions and partnership during his tenure as Cerence’s CFO and look forward to his continuing support as Cerence’s board member. With that, I would like to hand the call over to Dan to review our Q2 results in detail and share more about our guidance for Q3 and the full fiscal year. Dan?

Daniel Tempesta: Thank you, Stefan. Before I begin, let me just say to our shareholders that while this is clearly a challenging quarter to come on board, I am optimistic about the roadmap and new products that Stefan discussed. Also, I look forward to meeting with many of you during the several investor conferences and NDRs we have in the coming weeks. Turning to our results, our Q2 revenue of $67.8 million was above the high end of the guidance, mainly due to an unplanned fixed license of approximately $5 million. This license was directly related to a settlement of an obligation created by a large customer’s over reporting of royalties discussed and reported on last quarter’s conference call. In addition, our connected services revenue line also benefited from an unplanned OEM underreporting true up of approximately $2.6 million.

Excluding these unplanned items, revenue would have landed within the lower end of our Q2 guidance range. Our adjusted EBITDA for the quarter was approximately breakeven and benefited from higher than expected revenue in the quarter. Our Q2 profitability was negatively impacted by approximately $6 million related to the write off of a long-term unbilled contract asset associated with one of our non-automotive customers that declared bankruptcy during the quarter. Our cash flow from operations was $1 million and our balance sheet had total cash and marketable securities of approximately $115 million. As Stefan mentioned a few minutes ago, our GAAP results were also negatively affected by $252 million goodwill impairment. This is a non-cash impairment charge that only affects our GAAP results.

Turning to our detailed revenue breakdown, variable license revenue was $25.1 million, down 4% from the same quarter last year and up 21% sequentially quarter-over-quarter. Fixed license revenue came in at $10.4 million for the quarter, $5 million higher than originally expected due to the unplanned fixed license previously mentioned. Looking forward, we expect $20 million of fixed licenses in the third quarter. This will bring our fiscal 2024 fixed license total to approximately $30 million, including the unplanned $5 million settlement, which is above our initial expectations of $20 million. Connected Services revenue, excluding the legacy contract, was $13.6 million and as discussed earlier benefited from the $2.6 million true-up from underreporting by a customer, resulting in 30% growth for the same quarter last year and up 33% from the prior quarter.

Excluding the true-up, connected services revenue was approximately $11 million, up 8% compared to the prior quarter. Excluding the impacts of legacy and the true-up, we expect only a modest ramp in connected services in the second half of 2024 compared to the first half. Our Professional Services revenue was flat year-over-year and down 10% quarter-over-quarter. As a reminder, while Professional Services is an enabler of both license and Connected Services revenue, we expect Professional Services revenue to remain generally flat. Going a bit deeper into our variable license revenue, we have adjusted this schedule, we have adjusted this schedule. First, we’ve added a row to highlight the periodic adjustments that can occur with OEM reporting.

While there are always small adjustments that can occur in the ordinary course, our intention is to include within this line individual OEM related adjustments that are greater than $2 million in any given quarter. This will allow us to highlight items that are impacting the variable license trends. Second, we have updated the format to show at the bottom of the page the operational metrics that we have discussed and presented in the past. As previously mentioned, variable license this quarter was $25.1 million. Looking at our operational metrics, consumption of our previous fixed license contracts totaled $14.5 million this quarter, a reduction of 14% compared to the same quarter last year and in line with our expectations. As a reminder, because we have been managing down the annual value of fixed contracts, over time this will result in a smaller consumption of royalties associated with past fixed contracts.

As consumption levels decline, we expect that should correspondingly result in variable license growth in future periods as royalties will accrue directly into revenue as production occurs. We continue to expect to normalize our consumption run rate by the end of fiscal year 2026, at which time any new fixed contracts should roughly align to the level of consumption during the year. Our pro forma royalties were $39.6 million and show a recent declining trend. As we review our key performance indicators this quarter, our penetration of global auto production for the trailing twelve months remained steady at 54%. We shipped 11.7 million cars with Cerence technology in the quarter, down 6% year-over-year, while IHS production for the same period declined 1%.

Cars produced that use our connected services increased 23% on a trailing 12-month basis compared to the same metric a year ago as some programs that were previously delayed went into production. Total adjusted billings increased 9% in the second quarter compared to the previous year. Turning to our five-year backlog metric, we are making an approximately $200 million reduction to our five-year backlog, which brings that figure to approximately $1 billion. Incorporating the impacts just discussed, we are guiding our third quarter revenue to be between $66 million and $72 million, which includes the $20 million fixed license previously mentioned. For the full fiscal year, we expect revenue to be between $318 million and $332 million. Excluding the impact of any restructuring activities that may occur as we consider cost reductions, we expect fiscal year 2024 cash flow from operations to be in the range of $5 million to $15 million.

Before I provide our thoughts on fiscal 2025, since the legacy Toyota contract is now behind us, I think it’s important to discuss the 2024 revenues excluding the impacts of those services. We believe this view provides the new run rate revenue profile for the company. If you take the midpoint of our current fiscal year 2024 revenue guidance, I just discussed on the previous page of $325 million and exclude approximately $87 million of legacy related revenue recognized in Q1, the adjusted revenue for the company for fiscal year 2024 is approximately $238 million. We consider this new estimated run rate revenue relevant for both assessing our cost model as well as planning our business activities going forward. As we exit the first half of fiscal 2024 with this new adjusted view of the run rate of our expected revenues, I do want to take a minute to look forward.

While I am not prepared to provide 2025 or mid-term guidance at this time, I can provide a framework for how to begin to think about fiscal year 2025 revenue. If you assume flat OEM production and flat pricing mix, similar to what is incorporated in our last 2024 guidance, our latest 2024 guidance, we would expect significantly less fixed license consumption in fiscal 2025 compared to fiscal year 2024 as our past commitments continue to wind down. In addition, if you assume $20 million in new fixed licenses in fiscal year 2025 and very modest growth in our run rate connected services, it would be reasonable to anticipate mid-single-digit growth off of the new estimated run rate of $238 million. For some additional color on the sensitivity of this view, those growth rates could be lower or higher depending on global auto production changes, date shifts in the introduction of new platforms and pricing and mix shifts.

Again, this does not represent guidance, but is rather a framework for how to think about fiscal 2025 revenue. Also, this framework is subject to change based on a number of industry and customer related factors. With regards to our business in the adjacent markets, as previously mentioned by Stefan, they are developing slower than anticipated. Although we do believe there is an opportunity for revenue growth in these markets in the mid-term, we are not expecting a meaningful uplift in revenue contribution in fiscal 2025. Wrapping up my comments, I’d like to leave you with a few key thoughts. We believe that Generative AI and LLM technologies are critical to our future product roadmaps, and we plan to ensure that our resources are focused to invest in these technologies and related product offerings.

Additionally, we believe that our position in the industry, our longstanding relationships with our customers, and our initial success with our recently announced Gen AI products provide us with a solid foundation to reinvigorate growth in the future. And finally, given the current financial headwinds, we plan to take cost actions in the near-term that will position us to deliver stronger profit margins and stronger cash flows. That concludes our prepared remarks and we will now open the call up for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And your first question comes from the line of Jeff Van Rhee with Craig-Hallum. Please go ahead.

Jeff Van Rhee: Great, thanks. Thanks for taking the questions. I missed the first monologue there was, I don’t know, it wasn’t live. So my apologies if I’m repeating stuff here, Stefan, but if you look at the magnitude of the reduction at the midpoint on the revenue picture, and obviously a very material number, when you look at what’s being taken out, how does that affect your thinking about share gains, share loss, competitive landscape? Just start to parse that a little deeper, if you would.

Stefan Ortmanns: Yes, okay, maybe. Good morning, Jeff here, and let me give you also my view and then also ask Dan for his thoughts here. Yes, so after receiving the Q1 royalty reports, we observed some downward trends here. And then we conducted in Q2 a deep dive account by account reviews starting in February and we finished in April. And we observed a couple of factors resulting in a reduction in forecast. So first of all, our forecast projection based on the latest data and some of the historical trends and data we have, and then we compared this also with the input from customers, the input from HIS. We still have a high penetration of 54%, but for this fiscal year, IHS is flat. We assumed also a growth of 3% and we saw also a decline quarter-over-quarter of 12%.

Now, bringing this together, as you mentioned also in earlier calls, right, we see also some impact of delays in programs and also that means delay in start of production and also a slower ramp of new programs here and of course, this is hitting the revenue forecast and also it was driven by a higher PPU. This goes actually into the line of the core business, running royalties, but we see also another aspect here, a slower ramp in two wheelers than originally anticipated. That’s the first part of my answer. And the second part, obviously I would like to split your market share question, using your market share in actually two parts. One is related to a real-time adjustment. And as you know, in the past, we lost some deals here, but this was already baked into our original forecast.

We are completely convinced that based on our success at CES we have a lot of opportunities also for winning back, and we believe also that the large hyperscalers are not performing and as I mentioned also earlier, since CES, so within the last couple of months we won six OEM programs. Right? And currently we are working on pre-development programs of about 14. That shows actually that we are on the right track with our new Gen AI roadmap.

Jeff Van Rhee: Along the lines of the second part there, if you look at the competitive win backs, you said you’ve got a bunch of them kind of percolating here. Can you expand on that a little bit? In terms of the last couple of years, where have the competitive losses taken place and in terms of against who? And then secondly, those that you think are on path to win back, where do you see most of your win backs coming?

Daniel Tempesta: So, when looking back, that was actually prior to the spin at Nuance days, so we lost, for example, GM against Google. There was another loss at Volvo and a few others, but I think now we have huge opportunities for winning back a lot of deals here and also with our new product roadmap, and also with our new AI computing platform, I think we are forward to a breakthrough here for the conversational AI in the automotive world. And that’s the feedback from more or less all OEMs across the globe.

Jeff Van Rhee: Yes, I mean, obviously, a lot of the OEM programs, and particularly around software, have struggled mightily. So certainly there have been some delays, although it seems your revenue is falling short of that. Is there any reduction now versus their expectations? The OEMs a year ago, 18 months ago, in terms of the quantity of your product they’re taking and expecting to put into each car, the [indiscernible] car?

Stefan Ortmanns: I mean, when looking at the current automotive trends, I see, or we see actually three major trends. One is related to EV, and we are all aware that there is a slowdown in the EV field. Secondly, as also mentioned, the software defined cars, it’s creating another dimension of complexity. And unfortunately, we’re seeing also some delays in new programs where we can provide actually a higher PPU for our CRI that’s missing and the third one is emergence of Gen AI. And this is really appreciated by more or less all car makers across the globe, even in China, in Europe and North America.

Jeff Van Rhee: Okay, I’ll leave it there. Thank you.

Operator: Your next question comes from the line of Nick Doyle with Needham. Please go ahead.

Nick Doyle: Hey guys, thanks for taking my questions. The first one on the fixed contract consumption, I understand you’re talking about lower consumption over time and the drivers around that, but near-term, should we expect that same $15 million level, $14 million, $15 million level through the fiscal year 2024? And can you give a little more detail on the fiscal 2025 consumption; is maybe less than half of the rate that we’re seeing in 2024 a good place to be modeling wise? Thanks.

Daniel Tempesta: Hi Nick, how are you? This is Dan. Thanks for the question. I do think in general, the remainder of the year, the past trends are good indicators of sort of the remainder of the year. That’s the first part of your question. But remember what I said about 2026. By the end of 2026, we should be starting to get close to parity of the fixed licenses that we do in those years. And our goal of course, has always been to get to $20 million. So that’s our intention next year. And if we change that intention, we’ll let you know. But just take that as our expectations at this time. So if we get to a $20 million level or approximately, and we’re at that run rate, you could expect that to come down over the next two years. So that should give you some indicators of how that’s going to come down next year and the year after to get to that landing point.

Nick Doyle: Yes, that’s helpful. And the base that we’re running on the fixed contract base is around $60 million today?

Daniel Tempesta: Yes, approximately. It was a little higher last year. That number can fluctuate up and down, but that’s a reasonable estimation.

Nick Doyle: Thank you. And then my second question on the ASP, the average billings per car, I think we saw a nice increase off the bottom this quarter, but I mean, given all the moving pieces in your guidance, it seems like ASP is maybe flat, possibly down. I mean, fourth quarter could be up. I mean, just a little more detail on how the ASPs are trending through the year. And because it seems like what we kind of come out with on 2024 is a good way to model to go forward.