Cerence Inc. (NASDAQ:CRNC) Q3 2023 Earnings Call Transcript

Cerence Inc. (NASDAQ:CRNC) Q3 2023 Earnings Call Transcript August 8, 2023

Cerence Inc. misses on earnings expectations. Reported EPS is $-0.04 EPS, expectations were $0.15.

Operator: Good day, and thank you for standing by. Welcome to the Cerence Quarter Three 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Rich Yerganian, Senior Vice President of Investor Relations. Please go ahead.

Rich Yerganian: Thank you, Brittany. Welcome to Cerence’s third quarter fiscal year 2023 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, goals, targets and plans should also 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, our Form 10-Q filed on August 8, 2023 and our Form 10-K filed on November 29, 2022.

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; Tom Beaudoin, CFO of Cerence and Iqbal Arshad, our Chief Technology Officer. As a reminder, the only authorized spokespeople for the company are Stefan, Tom and me. Before handing the call over to Stefan, I would like to mention that we will be presenting at the Goldman Sachs Communacopia Tech Investor Conference in San Franciso on September 6, in a Raymond James Virtual Lean, Mean and Green Vehicle Investor Conference on September 18.

Now onto the call. Stefan?

Stefan Ortmanns: Thank you, Rich. Welcome everyone and thank you for joining us to discuss our third quarter results. There were several important developments in the quarter I’d like to highlight. First, we delivered solid results with revenue of approximately $62 million come in at the high end of our guidance. In addition, our strong focus on operational excellence contributed to all profitability metrics, performing better than expected, except for GAAP net income, which included a charge associated with our convertible debt financing. Operationally, we delivered on everything we committed to invest on our last call. I’m extremely pleased with the progress the company has made in the last 12 months creating an organizational structure committed to three key principles.

First, continue to lead innovation in AI for the transportation space. Second, delight our customers with on time and quality products. Third, win strategic accounts that support our long-term growth. At the core of our commitment to innovation are the enhancements we are making to several Cerence products using large language models and generative AI. Iqbal will detail these important product updates in his remarks. At a high level, our deep expertise in AI for automotive and strong OEM relationships put us in a unique and favorable position to partner with our customers, to deliver game changing application of these technologies. Bringing us one step closer to our future product vision, the immersive companion. As a result, Cerence remains well positioned to capitalize on the transformative trends within AI incorporating new inputs into our prototype mobility AI platform as we continuously strive to enhance customer experience, and expand product functionality.

Our core auto business continues to perform well with our global outer penetration rising to 54%. That means that 54% of total new global live vehicle production includes some level of technology from Cerence. This is the third consecutive quarter of increasing penetration. And this figure is now the highest we have seen in nearly two years. This elevated level of penetration continues to be a straightforward endorsement of Cerence’s superior technology. Tom will comment on the product mix associated with this market expansion in a few minutes. While there are some crosscurrents, creating a level of uncertainty about the macroeconomic environment, we remain quite confident in our visibility and our ability to deliver a strong Q4 and full fiscal year.

While semiconductor shortages for the outer industry are becoming less of an issue, the uncertain effect of rising interest rates, and the slowing global economy remains a modus concern on auto demand and production. We are monitoring this closely and have considered this for our Q4 and full year guidance. Also in the quarter, we successfully restructured our debt through the issuance of new convertible notes, we use the proceeds to pay off the term loan that was at a high variable interest rate and to buy back half of the existing notes at half the coupon rate. The net effect is cash interest savings of approximately $8 million a year by moving a sizable portion of our debt from 2025 maturity to 2028, where we are pleased with the results of the transaction.

Overall, we continue to make solid progress across key areas as we advance to a destination next, our vision for the future for all aspects of our business, product innovation, target markets, and the financial model and performance. We believe in our ability to achieve our long term objective of double digit revenue growth with strong EBITDA margins. And across, one of the keys to achieving our long term objective is winning new business with customers. Securing new business and next generation platform win is key to our future success. As many of you know once designed in you are the supplier of the technology for the program’s life. This means a new contract can generate revenue for many years. I’m happy to say that in Q3, we had several strategic wins, and I’m expecting additional ones in Q4.

In our core auto business we had two strategic wins. The first was for major Japanese OEM where we displaced a competitor to provide connected services. The second was for our emergency vehicle detection technology for a major Korean car company. We also continue to make progress in the two wheeler and truck markets. We were excited when iconic moto cycle brand chose our technology over several other competitors, including niche players and consumer tech. While revenue contribution from the two wheeler segment is expected to be small this year. Four two wheeler solutions started production in Q3 and should support revenue growth in this segment in FY24 and beyond. Our sales team is laser focused on finishing the fiscal year strong, and I’m confident we will win key strategic pipeline opportunities to drive our business forward.

We continue to be extremely pleased with our continued success and building upon our strong core and capitalizing on adjacent market opportunities. On our Q4 earnings call, Tom will provide you with an update on bookings and their expected contribution to backlog and revenue growth. While it may be repetitive for some of you, I want to again highlight our operational priorities as they are vitally important to our near and long-term success. This means meeting or exceeding our customers’ expectations for our technology, maintaining a strong competitive advantage, continuing to focus on operational excellence and locking down to new business opportunities in front of us, including several wins back opportunities. We believe very strongly in meeting our commitments to our customers, employees and you, our investors.

We are on a strong track to deliver fiscal year results better than we anticipated at the beginning of the fiscal year. With that I’m excited to have Iqbal Arshad, our Chief Technology Officer on the call with us today. Since joining the company three plus months ago, Iqbal has had an immediate impact. And we’re excited about how he and Nils Schanz, Chief Product Officer are teaming up to execute the future vision and direction of our technology. Igbal will brief you on how we are leveraging the latest in generative AI and large language models to enhance our product offerings. I’m looking forward to how these advancements can help us deliver a truly immersive companion experience to our customers. And I look forward to the role Cerence can play in continuing to unite a wide array of technology in the car while maintaining a uniquely branded experience for our customers and delighting our end users.

Iqbal?

Iqbal Arshad : Thank you, Stefan. With decades of extensive vertical expertise in the automotive industry and a rich history of leading AI innovation, Cerence is uniquely positioned to bring the latest advances in AI into the car. We bring unmatched experience and knowledge to the application of generative AI and large language models in transportation, as well as a strategic methodical focus on creating groundbreaking user experiences. As we envision the future of in car experiences, we are keenly focused on solving user problems by harnessing transformer base foundational AI models. These models enable us to develop intuitive voice and multimodal user interfaces, as well as generative AI applications that empower our customers to deliver high value user experiences.

These new capabilities seamlessly extend our existing AI based product portfolio. At the core of this offering is a next generation Cerence Assistant powered by generative AI. Through the implementation of large language models in our architecture, we are taking significant strides towards realizing our vision of an immersive companion. The Next Generation Cerence Assistant is optimized to provide users with more natural, intuitive and accurate interactions. Cerence Assistant, it deftly handles complex queries and multi-step tasks within a single request. The assistant’s deep customizability cares to both our automaker customers and end users, effortlessly adapting to their preferences as it learns. Please allow me to show you some of Cerence Assistant’s new generative AI powered capabilities.

Pixabay/Public Domain

[Video played] Designed to be friendly, helpful and enjoyable. The Next Generation Cerence Assistant adds meaningful value to drivers daily journeys. These capabilities will be available to our existing Cerence customers who will greatly benefit from these new generative AI powered features. In addition to Cerence Assistant, we continue to gain traction for a generative AI powered car knowledge product discussed during our last quarter’s earnings call. Cerence car knowledge offers users real time contextual answers to all car related queries. We are engaged with customers globally to adopt and expanded car knowledge product that leverages large language models and the specific data associated with a car supplied by the OEM. This is just the beginning.

We are expanding our architecture with fine tune LLM based on our curated transportation data and leveraging our industry leading edge technologies like audio AI, automatic speech recognition, neural text to speech, biometrics, emotional AI and in car communications to create the future of automotive user experiences. I will now turn it over to Tom to review the Q3 results in more detail.

Tom Beaudoin: Thank you, Iqbal. I will review our guidance for Q4 and the full fiscal year in a moment. But first I want to share more details on our Q3 results. Our Q3 results continue step on my commitment to consistently deliver on our guidance. Q3 revenue came in just shy of $62 million at $61.6 million at the high end of our guidance. This is due to strength in our core business. As we guide it on our last call, we closed a new fixed contract in Q4 originally planned for Q3. Consumption of fixed contracts was higher than expected. I will explain why in a few minutes. As revenue came in at the high end of the range, combined with our focus on operational excellence. We exceeded most of the key profitability metrics we guided for the quarter.

Non-GAAP gross margin was 66.5%, non-GAAP operating margin was a positive 0.05%, adjusted EBITDA was $2.8 million, or 4.5% margin and non-GAAP loss per share was $0.04. Except for GAAP net income, which was impacted by the refinancing of our convertible debt. Most key financial metrics came in above the high end of our guidance. During the quarter, we had negative cash flow, as expected, cash flow from operations was approximately negative $8.2 million. We expect positive cash flow in Q4 and for the full fiscal year. Our balance sheet remains strong with total cash and marketable securities of approximately $116 million. Here’s our breakdown of revenue for the quarter, variable license revenue was dropped 16% from the same quarter last year, and down slightly quarter-over-quarter due to a higher than expected level of fixed contract consumption.

As you will see, in a few moments, our penetration of global auto production rose to 54% as we continue to maintain a strong position in the market, the higher level of penetration is partially due to single component solutions in emerging markets, which yield a lower revenue per car. We view this as a strategic market expansion opportunity and potential launching point for gaining further business and eventual higher TTE use with OEMs in emerging markets. New connected services revenue was up 3% From the same quarter last year, while down 3% from the last quarter. You may recall last quarter; we had a true-up of approximately $700,000 from a customer. Adjusting for the one time true-up, new connected revenue was up quarter-over-quarter. We expect our new connected services to continue to ramp up in FY24 and several key programs that have been delayed by customers go into production.

Finally, and as expected, our professional services revenue was down 24% year-over-year, and down 8% quarter-over-quarter. As we have stated previously, professional services will vary based on the progress or completion of customer projects. We do not project professional services as a revenue growth driver for the company, but instead as an enabler for future license and connected revenue. Additionally, our newer products and solutions include improved implementation and integration features, which lowers the requirement for professional services. Moving on to the details in our license business. Overall, the license business remains strong and is indicating improvement from the issues that have plagued auto production over the last few years.

While the semiconductor shortage seems to be receding, the macro economy and especially higher interest rates have the potential to slow demand and production growth. This and other factors have led IHS to reduce their calendar year production growth to 1%. Pro Forma royalties were up 7% year-over-year and 6% quarter-over-quarter due to the increased auto production and penetration of our technology. Part of the growth in pro forma royalties in the quarter was due to a one time true-up with a customer that had under reported royalties of approximately $1 million. Most of this upside revenue was reported in consumption as this customer was operating under a minimum commitment deal. As a result, you can see higher than expected consumption in the quarter.

Our Q3 pro forma royalties represented the highest amount in over two years, even when adjusting for the true-up. As we discussed in the call last quarter, we pushed out an expected fixed contract from Q3 to Q4. As a result, we did no fixed contracts in Q3. Since the quarter closed, we have signed the expected fixed contract and we will be staying within our commitment of $40 million for the full year. As you may recall, we have previously stated we model prepay fixed contracts based on an assumed six quarter consumption period. We have also noted the Q1 fixed contracts that we signed had an expected consumption over eight quarters, leading to lower consumption in FY23 versus our model and extending consumption through FY24. The fixed contract we signed in Q4 has an expected consumption period of four quarters shorter than our model.

The net effect of the prepaid contracts we signed in FY23 will yield lower FY23 consumption versus our model and estimated higher consumption of approximately $10 million in FY24. We are providing you as an additional data point this quarter regarding fixed contracts. We expect the inventory balance of fixed contracts at the end of fiscal 2023 to be approximately $98 million, down from approximately $125 million at the end of fiscal 2022. We currently estimate the balance of fixed contracts to be approximately $70 million at the end of FY24 and approximately $57 million in FY25. The balance at the end of each year assumes the addition of $40 million of new fixed contracts, less expected six quarter consumption. The majority of our KPIs continued to indicate strength in the business.

Our penetration of global auto production for the trailing 12 months, increased to 54% from 53% last quarter. This means over half of global auto production includes some level of Cerence technology. 12.2 million cars with Cerence technology were shipped in the Quarter. This is up 25% year-over-year and reflects the approving production environment and our continuing strong competitive position. Cars produced that use our connected services increased 50% year-over-year, and reflects the trend of more and more cars being connected and the growth of our ability to successfully provide our customers with innovative cloud based solutions. We also saw a large increase in monthly active users 29% year-over-year, indicating increased popularity among consumers of our technology.

Billings per car KPI declined 6% including a negative FX impact of 200 basis points. The decline is primarily due to product mix. Some of the new business contributing to growing license and increased penetration is coming from emerging markets where OEMs initially are adopting components of our full software stack. These are important wins that are driving penetration and the opportunity for these customers to drive higher revenue per car over time as they adopt additional components of our technology. The other factor which we mentioned on our last conference call are macroeconomic and OEM driven delays in the start of production, a higher price per car next generation platforms. We see a positive trend in this KPI and expected to trend higher over the next few quarters.

Now turning to revenue guidance for Q4 and fiscal year, as I mentioned earlier, as expected, we close the Q4 fix contract of approximately $13 million. For Q4, we are guiding revenue from $72 million to $76 million for Q4. The tight range is due to knowledge of the fixed contract already closed and strong visibility to our other revenue sources. With our strong first three quarter results, and strong visibility to Q4, we are providing a narrow range for our full fiscal year guidance of $286 million to $290 million, raising the midpoint of our full year guidance to $288 million. You can see on this slide, the revenue guidance and the effect of the associated financial metrics. Overall, the business continues to perform. As we outlined at the beginning of the fiscal year, we remain focused on innovation, operational excellence, and strong bookings in the second half to achieve our long term goals.

This concludes our prepared remarks. And now we will open the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Colin Langan with Wells Fargo.

Colin Langan: Oh, great. Thanks for taking my questions. Just want to follow up on I think you made some comments on billings they were down again year-over-year. I think at your Investor Day, you talked about kind of going from 380 to 480 in ‘23 to ‘24. How are you tracking now? I mean, is the ‘23 actually lower, cost of billings is coming in lower? And is there risk to 2024 sales targets if some of these launches get pushed out too much?

Tom Beaudoin: Yes, so first of all, the metrics are related but different. So the numbers that you talked about were the embedded TTE use, and as we’ve talked about, we have seen some production delays across the OEMs. And we’ll provide updated — will provide our guidance for ‘24 in November. With respect to billings per car, which includes both embedded and connected, it’s a factor of that which some of those higher TTE use and get delayed. It’s also a factor of I think this is a trailing 12 month metric. And I think during some of the supply chain shortages, some of the OEMs were leveraging to the higher cars, which have more of our technology. And that as we just pointed out, some of our highest penetration is driven by winning new opportunities in emerging markets where they start out with one or two of our components, and therefore it has a relatively lower billings per car, but does provide an opportunity for accelerated penetration for winning additional business with those OEMs in those markets.

And then adding additional components and features over time in association with those OEMs.

Colin Langan: Got it. Thanks for the caller. Just a second question. The other KPI that sort of stood out as the contract duration was 6.4 years, I think it was in Q4 it was seven years. What is causing the contract, average contract to shrink? What is driving them?

Tom Beaudoin: It’s just a mix issue of deals and how those deals play out. I mean, it’s still it depends on how OEM sign up for production schedules. It’s still a quite a long commitment level for OEMs.

Operator: Our next question comes from the line of Luke Junk with Baird.

Luke Junk: Good morning. Thanks for taking the questions. I wanted to start with a follow up question on the Billings per car metric again really through the lens of what you’re expecting from content per vehicle standpoint in fiscal 2024. And specifically, I’m just wondering to what extent, the single component solutions that you’ve spoken to today, were already contemplated in outlook or just how they impact the outlook for fiscal ‘24 in general, for starters, thank you.

Tom Beaudoin: Thanks, Luke, I really can’t comment much on FY24, will provide our ‘24 guidance. And we’ll take a look at the longer range plans when we do the Q4 guidance in November. But I think if you look across almost all the KPIs, it does show that we’re continuing to win new business, we’re continuing to get more active users that connected and embedded are continuing to grow. And the billings per car I think is just a factor of all the things that I mentioned. And it does provide some growth opportunities for us with some of these newer OEMs and some of these emerging countries. And so I don’t think it’s a bad thing. Got it.

Luke Junk: Got it. And then for my follow up, maybe it just a bigger picture question, a question of revenue models going forward. So the press release discussed the idea of positioning Cerence as an enabler for large language models and consumer tech in the car, sitting on top of the white label proposition that we all know. Just wondering to what extent you think you can get paid for that incrementally? And just any thoughts you can share on what that revenue model might look like? Are you conceiving as something that’s more license like that would be one time? Or can we see more connected, like, sort of subscription models come out of this? Thank you.