Cerence Inc. (NASDAQ:CRNC) Q2 2023 Earnings Call Transcript

Cerence Inc. (NASDAQ:CRNC) Q2 2023 Earnings Call Transcript May 9, 2023

Operator: Good morning, and thank you for standing by. Welcome to the Cerence Second Quarter 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. As a reminder today’s conference is being recorded. And I would now like to hand the conference over to your speaker today, Rich Yerganian, Senior Vice President of Investor Relations. Rich, please go ahead.

Rich Yerganian: Thank you, Eric. Welcome to Cerence’s second 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 May 09, 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; and Tom Beaudoin, CFO of Cerence. 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 have 7 Investor Conferences in the next few weeks. Please refer to the upcoming events section of our IR website for specific dates and conference information.

Now onto the call. Stefan?

Stefan Ortmanns: Thank you, Rich. Welcome everyone and thank you for joining us to discuss our second quarter earnings. We delivered solid results with revenue just over $68 million coming in above the high end of our guidance. In addition, our strong focus on operational excellence contributed to most profitability metrics performing better than expected. This includes generating free cash flow of over $5 million in the quarter. Our core auto business continues to perform well with our global auto penetration rising to 53%, that means that 53% of total new global light vehicle production includes some level of technology from Cerence. Tom will provide the details of our performance in a few minutes. We continue to maintain a strong competitive position against both niche players and consumer tech.

Bookings for the first half of the year included multiple strategic wins with a solid pipeline of identified opportunities, we expect a strong second half of bookings. Cross Cerence remain in the macroeconomic environment, while semiconductor shortages for the auto industry are incrementally better, the uncertain effects of rising interest rates and the slowing global economy on auto demand remain in place, offsetting any likelihood for a near term significant ramp of production aligned with our fiscal year IHS is forecasting 4% growth. This is slightly better than our original assumption of 3%. Accordingly, we have raised the low end of the range for our full fiscal year revenue guidance from $275 million to $280 million. While it is a recent event and not part of our Q2 results, I’m excited to announce Iqbal Arshad as our new Chief Technology Officer.

Iqbal will lead Cerence global technology and platform organization responsible for providing leadership for our technology vision building innovative user experiences and accelerating our roadmap. Iqbal’s impressive career in technology leadership includes senior technology, engineering and product development roles at Motorola, Google and Lenovo. He brings a wealth of experience having shaped some of the most exciting technology development of the past decade, including industry first innovations like the original Droid smartphone, Google’s first Android tablet, the first mobile AI voice assistant, and the first Android smartwatch. Iqbal has deep expertise across AI, IoT, software and mobile technologies. That will be immensely valuable not just for our automotive and transportation customers, but also as we look to potential expansion opportunities outside of transportation.

I am very excited to have Iqbal as part of our executed leadership team to help us achieve our destination next innovation goals, working closely with Nils Schanz, our Chief Product Officer. I’m very confident that Iqbal will be a critical leader as he continue to spearhead the industry in applying AI in innovative ways for the transportation market. Moving on to bookings, which for the first half were $263 million. This is up 11% from the second half of fiscal ’22. Additionally, while the timing of when bookings occur is always difficult to predict, the pipeline of sales opportunities for the second half looks strong. In the first half, we had seven very important strategic wins, including three win-backs, two from customer tech companies and one from a niche competitor.

In Q2, a key win-back was for connected services for a global luxury brand for the North America region. This win further validates the competitive strength of our solutions building off the success with this customer in other regions. As an added benefit because we are already delivering these cloud based capabilities for this customer and other regions, the implementation of our solution for North America is shorter. They will be switching over to our solution in North America later this calendar year. One of the other strategic wins during the first half was with the largest carmaker in China to support its global expansion. We will provide Cerence’s assistant capabilities in more than a dozen languages. This is consistent with other China OEMs turning to Cerence Solutions as they look to expand their business globally, demonstrating our unique leadership in Voice AI and the broad portfolio of languages we support.

The other strategic wins were in Europe, India and the U.S. These strategic wins reinforce the strong competitive position we hold and the continued superiority of our technology and solutions. This AI at the core of our product innovation, we remain sharply focused on leveraging new technology to bring innovative new products to the transportation and AIoT markets. One such example is recent enhancements we made to Cerence Car Knowledge, a valuable product for automakers and their drivers that enables real time credible intelligence about all aspects of the car. Most recently, we have leveraged Cerence developed generative AI and large language models to enhance Car Knowledge, demonstrating our continued capability to leverage the latest in AI innovation to further improve the in car experience.

With this enhanced version, drivers can ask questions about questions about the car’s features, vehicle status and more. Car Knowledge leverage data from the car sensor combines with user manual data to provide specific tailored answers. Because the responses are sourced purely from OEM provided data and are tailored to the specific car, the driver can be confident the results are accurate. Cerence’s Car Knowledge is becoming very popular with OEMs with a strong pipeline for the enhanced version. During the quarter, we also released our newest version of Cerence Assistance, the foundational technology for the immersive companion experience. This latest version includes new features like Just Talk, Emotional TTS, Capabilities, and Apple Music integration.

Just Talk is just as it sounds. Instead of pressing a button on the steering wheel or saying Hi Cerence, the driver speaks simply what they want to do and the car will understand if it is a request for the assistant to respond to or whether the person was talking to another person in the car. No more need for a wig upward. Just talk to your car like you would to another individual. Truly groundbreaking technology. This technology is currently being integrated in the new Mercedes Benz platform shipping this summer in the E-Class. The first to be the customers started production into two with our Cerence right product and we expect two more in Q3. At its core, Cerence Ride uses our Cerence Assistant technology but enhanced to provide unique features for the two wheeler market.

These features include applying our audio AI technologies in new ways to account for the open cabin noise environment of a two wheeler. As you would expect, the noise environment creates some unique challenges for natural language understanding but our team has done an amazing job achieving the accuracy levels needed for achieving an enjoyable user experience. During Q2, we continue to enhance several key AI technologies, including our Neural network based emotional Text-To-Speech product. Using our emotion detection technology, the assistant can address the emotional states of the driver. For example, if a driver is experiencing road rage, the system can respond in a calming voice using the appropriate pitch and inflection accordingly. This is similar for other situations including fear, surprise of .

It is truly amazing to hear how our technology can deliver verbal responses based on the driver’s emotional state. We also continue to refine and expand coverage for our emergency vehicle detection technology. There are upwards of 1500 unique emergency vehicles found throughout the world and we believe we offer the most extensive and accurate coverage. In fact, one of our customers compared our EVD solution to two others and our AI based technology came out on top. The other significant advancement we made in the quarter was with our voice biometrics capability. We have developed an updated version of this technology. Much like fingerprinting is used for identification, our voice biometric product can identify unique human characteristics and person voice that can be used for digitally identifying a person to provide access to systems, devices or data.

In an era, where voice is an increasingly popular enabler of many different types of transactions being able to accurately recognize who is placing an order or making a request is vitally important. On the innovation front, I’m really excited about what our engineering teams have done to elevate our product offering. And I’m equally excited about the new innovations we will be bringing to market under the leadership of Iqbal and Nils. Before I hand the call over to Tom to review our Q2 results and Q3 guidance in detail, I would like to summarize the priorities I have set for the company for the full fiscal year. It is all about operational excellence which covers all aspects of our business from meeting and exceeding our customers’ expectations, securing a strong second half of bookings, managing the business model and meeting our full year guidance.

The team at Cerence is well aligned and excited about delivering on these goals. I will now turn it over to Tom.

Tom Beaudoin: Thank you, Stefan. I’ll come back to guidance for Q3 in a moment. But first, I want to share more on our Q2 results. With a strong Q2 results, we are providing another positive data point and our goal to consistently deliver on our commitments. Q2 revenue came in at $68.4 million above the high end of our guidance. This is due to a combination of better than expected strength in our core business with higher than anticipated contributions from license, connected services and professional services. New fixed contracts and consumption of existing fixed contracts in the quarter was in line with expectations. Based on the higher revenue, we exceeded most of our key profitability metrics we guided for the quarter. Non-GAAP gross margin was 65.3%, non-GAAP operating margin was negative 0.1%.

Adjusted EBITDA was $2.5 million or 3.6% margin and non-GAAP loss per share was $0.04. With the exception of non-GAAP operating margin and adjusted EBITDA, these metrics came in above the high end of our guidance including a $3.8 million reserve for bad debt with a specific EV customer. Both metrics, non-GAAP operating margin and adjusted EBITDA were at the midpoint of the range. During the quarter, we returned to positive cash flow as expected. Cash flow from operations was approximately $6.6 million. Our balance sheet remains strong with total cash and marketable securities of approximately $123 million. There is a breakdown of revenue for the quarter. Variable license revenue was up 30% from the same quarter last year and essentially flat quarter-over-quarter.

The increase compared to last year were due to lower consumption of fixed licenses, slowly improving auto production and increasing penetration. New connected services revenue was down 5% from the same quarter last year, and up 6% from last quarter. The year-over-year decline was the result of several previously disclosed factors such as lower production of connected cars over the last three fiscal years due to semiconductor shortages and expiring contracts for older technology, separate from the legacy contracts. Finally, our professional services revenue was down 10% year-over-year and down 6% quarter-over-quarter. Professional services will vary based on the progress or completion of customer projects as the pro services team includes the individuals who directly interface with customers to customize and implement Cerence’s technology on next generation OEM platforms.

We don’t see professional services like revenue growth driver for the company, but instead it acts as an enabler for future licenses and connected revenue. Moving on to the details in our license business. Overall, the license business remains strong and is indicating slow improvement from the issues that have plagued auto production over the last few years. Pro forma royalties were up 7% year-over-year and 2% quarter-over-quarter due to increased auto production and penetration of our technology. This was the third quarter in a row of pro forma royalty growth. We signed fixed contracts in the quarter worth $4.6 million all as prepaid contracts. This was in line with our estimates going into the quarter of approximately $5 million. We continue to manage fixed contracts to an approximate $4 million level for the full year.

We initially had expected to execute on approximately $15 million of fixed contracts in Q3. We now expect no fixed contracts in Q3 and in the range of $5 million to $15 million in Q4 as we continue to negotiate these opportunities. Full year fixed contracts are now expected to be in the range of $29 million to $39 million. Consumption of fixed licenses declined 13% compared to the same period last year. The majority of our KPIs continue to indicate strength in the business. Our penetration of global auto production for the trailing 12 months increased to 53% from 52% last quarter. This means over half of global auto production includes some level of Cerence Technology. Of the total 11.8 million cars with Cerence Technology, those that use our connected services increased 27% quarter-over-quarter.

We also saw a large increase in monthly active users, 29% year-over-year indicating increasing popularity among consumers of our technology. The billings per car KPI declined 9% including a negative FX impact of 3 percentage points. Now turning to revenue guidance for Q3 and the fiscal year, one factor that will have an impact on our quarterly revenue is the value of fixed contracts in the second half of the fiscal year. As I mentioned earlier, we expect fixed contracts of approximately 0 in Q3 and $5 million to $15 million in Q4. Taking that into consideration, we are guiding revenue from $58 million to $62 million for Q3. With the first half behind us and taking into account the expected contribution range from fixed contracts in the second half, we are raising the low end of our fiscal year guidance from $275 million to $280 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. And 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.

Q&A Session

Operator: And our first question comes from Jeff Van Rhee with Craig-Hallum Capital Group. Jeff, your line is open. Please go ahead.

Jeff Van Rhee: Great. Thanks for taking the questions. Guys, real nice quarter. It looks like everything is tracking well and connected units, a bunch of things to like here. In terms of the billings per car TTM, I think that’s decelerated last couple of quarters. Cerence very few going the wrong way. What’s going on with the billing per unit?

Stefan Ortmanns: Thanks, Jeff. It’s – a little bit of it is mix and how the OEMs are reporting each quarter. We also noted that there was an FX impact this quarter. And some of that is also the implementation of new projects and programs, which as we’ve talked about previously some of the new ones do carry a higher PPU. Those are really driven and dictated by the OEMs. So some of that is how quickly they’re getting those programs into production and therefore the billings and the royalty reporting flowing through the financials. So a bit of it is mix, a bit of it is FX and then a bit of it is, slight delays in some of the newer programs.

Jeff Van Rhee: How do you think about that number maybe over the next still a little longer duration over the next year or two?

Tom Beaudoin: Well, it’s critical. I mean as we talked about in Investor Day and as we continue to drive stronger bookings, particularly with some of the new innovation in the technologies that that Stefan talked about, we still have expectations for growing PPUs on both embedded and the connected side of the host.

Jeff Van Rhee: Great. And then just one other, obviously at the November Investor Day, you had talked about sort of projections or target models for the out years, not formal guidance, but gave us a sense of pretty dramatic EBITDA growth in FY24? But is that a hinged and start of production and particularly both on the two wheeler side as well as you were just talking about some of these price uplifts come in the new contracts that have yet to go to start of production. So I guess the question is starts of production both on the key automotive platforms as well as the two wheelers. Just talk about how those are tracking?

Tom Beaudoin: Well, we continue to drive those implementations with the core OEMs. I mean, we’re not updating any of the future year period. But this client will do that at the end of the fiscal year. And then as Stefan talked about, we continue to have strong win backs and program wins kind of as reflected in the bookings?

Stefan Ortmanns: So let me add a few things. Good morning, Jeff here Stefan.

Jeff Van Rhee: Good morning.

Stefan Ortmanns: I think we are making both progress here with all OEMs, you heard also with this leading Chinese OEM right, but also with European North American OEMs. On the two wheeler side, we have in total now seven wins, that’s great here. Two wheelers went live in Q2. We are expecting another big SOP in India, one of the top three two wheel manufacturer and then a legendary brand will go live also next – in Q3 in North America.

Jeff Van Rhee: Okay, all right great. And last one then, just you commented several times about the strength of the pipeline, and what it’s looking like at this point. Maybe just expand a little bit any particular geographies products, kind of coexist environments. What do you notice in that pipeline other than that obviously sounds like the magnitude has got you pretty excited?

Stefan Ortmanns: So I think, we have just launched just talk that was also presented by Ola Kallenius, CEO of Mercedes. This is a noble feature. As you can imagine, we see a great appetite for our new car knowledge with generative AI. Yes and we have also created a very cost sensitive approach here. We all know that ChatGPT is quite expenses, yes but we’re doing this also for a couple of years now working with large language models here. We see also a new appetite here for EBD emergency vehicle detection. We are progressing from my point of view in an excellent way with our new Cerence Assistant, right., We had also various strategic design wins, again, big tech. So we are on track in my view.

Jeff Van Rhee: Great. Thanks so much.

Operator: Okay. Standby for our next caller and the next question comes from Colin Langan from Wells Fargo. Colin, your line is open. Please go ahead.

Colin Langan: Oh, great. Thanks for taking my questions. Just a lot of follow-up on the bookings, I think you reported $263 million the full year last year was I think $648 million. So if I annualize the first half pace, it does seem like a step down from what you were doing full year last year. Any reason for the moderation are some of these contracts getting sort of pushed into the second half? How should we think about that?

Stefan Ortmanns: Yes, hey good morning, Colin, and thanks for the question here. So, the bookings are lumpy and difficult to predict the timing here. I think when comparing this first half of 2023 with the second half of 2022, we see a growth of 11% which is not bad at all. We have a very strong bookings pipeline, with identified solid opportunities for the second half. And we are quite confident that we will also convert this opportunities in very strong bookings.

Colin Langan: Okay. I mean is the thought that bookings this year will still grow or is last year just a tough comp, because it’s so high?

Stefan Ortmanns: We don’t provide guidance on bookings here, but also here we are on track what we also said at the earnings day.

Tom Beaudoin: I would just add that – bookings is the estimated value of the length of the entire contract. And the length of those contracts can vary quite widely by OEMs. Sometimes they’re five years, seven years, we’ve seen 10 year contracts. So some of that lumpiness we can still be winning significant amount of platforms. And as we’ve talked about, we’ve had a number of win backs. We haven’t had many losses at all. And that’s why at the end of last year, we tried to move to this kind of five-year backlog model, which we will update along with our guidance at the end of the year, which I think is a good indicator of kind of the medium to the visible revenue over the next two, three, four, five years. But I think as Stefan alluded to, there was growth above the second half of last year in this first year, and we have a strong pipeline for the second half.

Colin Langan: Got it, that’s helpful color. Just a quick question, you raised sales guidance and gross margin slightly, why either than operating income are still unchanged? Is there sort of SG&A inflation or it’s just sort of rounding?

Tom Beaudoin: Well, we did have to take a $3.8 million – bad debt reserve against the specific EV customer. We believe that customer is also having issues with other vendors. That goes into G&A. We made up some of that in the bottom line, because we had some FX impact, we had some better interest income and a couple of other factors. So that’s why you see a little bit of a shortfall. We’re still in the middle of the guidance level, but then we kind of made it up in OIE and other activities.

Colin Langan: Got it, all right. Thanks for taking my questions.

Operator: Standby for our next caller and the next question comes from Mark Delaney with Goldman Sachs. Mark, your line is open. Please go ahead.

Mark Delaney: Yes, thank you very much for taking the questions. You mentioned a handful of win backs that were achieved in the quarter and you spoke on some of the technology capabilities that led to it. But could you elaborate a little bit more on the pricing behind some of these win backs? And did you have to price more aggressively perhaps in order to bring customers back to Cerence? And how does that fit into the PPU commentary you previously articulated of that trending higher in the coming years?

Stefan Ortmanns: Okay. Good morning, Mark yes. I think it’s all about a rock solid technology as you can imagine right most of the OEMs doing also on the continuous – faces evaluation and benchmarking. In Q2, that was actually where we beat some niche player here, right? And now we are again back into North America for connected services. It has nothing to do with the pricing theme. It’s all about our expertise with AI with a very improved cloud AI stack, what I also said in some of the last earnings. And we’re bringing also more and more our vertical expertise. And I mean, it’s all about performance here, right.

Mark Delaney: Okay. So when you kind of look at these win backs overall, that is still consistent with the view of increasing PPU?

Stefan Ortmanns: Yes, yes.

Mark Delaney: Okay, okay. And then, so thank you that’s helpful. And then – my other one was around the revenue cadence 2Q, 3Q. Tom, you mentioned some movement around when some of these fixed contracts will be signed, if I heard correctly, what was going to go in the fiscal third quarter is now fiscal 4Q. Why is that moving around? Is there anything you guys are trying to do around getting better margins? It was just sort of normal timing or anything else you can share on – and the reason for the step down in the third quarter, but then comes back in 4Q? Thanks.

Tom Beaudoin: As we’ve talked about, we have a pretty -we have pretty good visibility to the pipeline for fixed contracts as we’ve stated consistently, this is a small group of Tier 1 customers. And so we kind of know when they would be up for doing either a new fixed contract as one expires or other activities. And as we look at that pipeline for the rest of the year, we feel that with a couple of these opportunities, we’ll be in a better position to negotiate those. We really do want to control the discount levels on these. And I think Stefan and I, it’s much more important to do that because as we’ve talked about these are already one deal. So we’re already achieving revenues on these. The customer may be under a current fixed contract that’s expiring.

So I think it’s important to really line up with the sales organization, line up with even the customers in some respects around the timing of those and what’s an appropriate win-win discount levels on those that gives them some of the cost reductions that they’re looking for but also provides the effective cash flow but not too high a discount that affects the consumption level on a go forward basis. So that’s the only real reason.

Mark Delaney: Thank you. All right. Please stand by. Our next question comes from Rajiv Gill with Needham. Rajiv, your line is open. Please go ahead.

Nick Doyle: Hi, this is Nick Doyle on for Rajiv Gill. Just wanted to ask again about the win back I guess there were two this quarter and one last quarter. Just if those affect your long term targets, if it’s incremental or already included in the model you provided at Analyst Day? And then if you could just talk a little bit more about how you won this back and if there’s any difference between winning back from the niche player versus the kind of big tech player? Thanks.

Tom Beaudoin: Let me — I’ll handle the first part and then Stefan, you can talk about the actual win back. Just from a financial modeling standpoint, we have bookings expectations to drive the medium and long term goals and sometimes they come from extensions and sometimes they come from new platforms and models and some cases, they come from win back. So I mean, all of these factors help us to drive towards the longer term models which will roll out in November.

Stefan Ortmanns: And when looking at the technical stuff of our solution, right, the win backs were driven actually by our new steering assistant. And we could convince that this new solution is easy to integrate. We could also show on OEM’s platform the benefits in terms of user experience in terms of accuracy and also in terms of fast response time behavior, right? And we addressed all the vertical needs for the OEMs. With this full flexibility for customization on top of our steering assistant and also offering the so called coexistence.

Nick Doyle: Thanks. And then for my follow-up, what are your assumptions for the autos in ’23 and ’24. And was the entirety of the raise really driven by the kind of IHS’s increase? Thanks.

Tom Beaudoin: I assume you meant ’23. So, yes, we had originally modeled in about 3% which at the time was significantly less than with IHS. So I think they were like 7%. The expense moved up to 4%. So as we’ve looked at our royalty reporting, I think we’re back in line with them at about 4% and our raise is really some portion of that plus as you saw, we’ve increased the penetration by a point over the trailing 12 months. So it’s a combination of those factors.

Nick Doyle: Thanks.

Stefan Ortmanns: Great. Thank you all for joining us this morning, and we will be in touch and hopefully see you at some of the upcoming conferences and investor events. Thank you and have a good day.

Operator: Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.