Cerence Inc. (CRNC) Earnings Call Transcript & Summary

Good morning, everyone. It's Jeff Osborne from Cowen. And thank you so much for tuning in for our 48th Annual Virtual TMT conference. I would love to be there in person, but I appreciate everybody taking time out of their busy mornings to listen in on Cerence. It's a company we just initiated on and, I think, they have a really interesting and differentiated strategy around sort of the human and machine interface within the vehicle. Very pleased to have Sanjay Dhawan, the CEO of Cerence joining us as well as Ritch Yerganian in the IR. And now, maybe, Ritch, I know you had a few slides to get started. But for those in the audience that aren't familiar with you folks, maybe we could just spend 5, 7 minutes or so on a quick overview of what you are. And then I had a few, what you are up to, and then I had a few questions to dive into if you don't mind.

Perfect. Jeffrey, good morning to the audience as well. I hope all of you and your families are safe and doing well, in a strange times for all of us. Having said that, absolutely delighted to be here this morning sharing our company with all of you. And just a quick introduction in case some of you are not familiar with the company. We're a new company. We were spun out of Nuance, is a leader in the voice technology, voice platforms. And basically, they had 3 businesses, a health care business, enterprise business and automotive business. The Autotech in a required its own in a kind of a focus, both from a technology standpoint and also from a go-to-market standpoint, and I'll tell you why in a minute. And the Board of Nuance took a decision a couple of years back to spun the company out into an independent company. And Cerence was created October 1, 2019, so last year. We're in our third quarter of operations right now. I was hired as the CEO. Just a quick intro. I have led many companies -- this is my fifth company that I'm leading as a President and CEO. The last 4 companies over the last over the last 20, 25 years were private -- private equity owned or venture capital owned companies. Some with even larger scales than Cerence, including an AKR company. And absolutely happy to be leading a public company now. We got a spun out and listed on October 1, like I said, and that's when Cerence was formed. Cerence, our focus is in transportation and mobility segment. So we're very focused on basically making the journey of a driver and a passenger in a more safer and more enjoyable in their cars. That's our vision that we are focused on. From a mission standpoint, we're, like I said, very focused on automotive ecosystem. And as many of you know, the car is getting more and more digital and more we provide digital platforms to do the human machine interaction, kind of the interaction of the driver with the car, and both inside the car and outside the car. As all of you know, when you're driving, your hands are supposed to be on the steering wheels, eyes are supposed to be on the road, and voice becomes a key interaction mechanism. And so -- and that's what we do. We provide AI-powered deep learning products, which basically enable these interactions, both for the driver and passengers in the car and outside the car. Next slide, please. This slide here just gives a quick overview of our company. Although we're a young company. As an independent company, the business has been in the makings for over 20 years plus, under Nuance. We have a very strong heritage of basically building voice and voice platform and products. We support 70-plus languages, which is probably the industry's best language coverage. And the reason that's important is, a, it's very hard to do, in order to basically extract speech and then extracting more importantly, the intent of that speech from -- on 70 languages, very difficult problem to solve from an AI and deep learning standpoint, and that's what we do. We pretty much have all the automotive OEMs, you'll see that as our customer, 65-plus customers worldwide, and have a fairly strong market share. We're the leader in the -- in the car, in the automotive space to provide the voice interactions. About 325 plus million cars on the road with our technology. In a typical quarter, we ship anywhere between 10 million to 12 million new cars every quarter. So about roughly 50 million cars, every year shipped with our technology. Roughly 1 in 2 new cars gets shipped with our products. So we're pretty happy with the way we have built our business up in terms of our leadership. Strong win rate. The thing that I'm also very proud of is our intellectual property. We have -- we own some of the core, core patents in this space. A very strong patent portfolio of 1,400 plus patents, with some of the core patents in the voice and human machine interaction inside a car. Next slide, please. This slide here basically talks about our product portfolio. Obviously, I cannot -- time doesn't allow me to go into the details of our complete product portfolio here. But at a high level, what we are about this we enable the OEM to provide an OEM experience and also have all the benefits associated by owning, not just that experience, but also the data that gets generated as a result of that experience. And so that's what we focus on. We start with voice as a core kind of technology to enable the digital experience inside the car, but we are basically supplementing that by adding other experiences as well. If you think about it, we as humans, use voice as 1 way of interacting. But then we also use gaze, we use gestures, we use our hands and so on. And so from a product road map standpoint, Cerence is clearly a leader on the voice side, but we're basically enhancing our products to kind of combine. As you see on the slide, Cerence Look, Cerence Gaze, other modes of interaction, we call it, multi-modality-based products to kind of design advanced experiences. So how that -- what that means from a user standpoint is while you're driving your car, you basically look on the right and say, "Hey Mercedes, what's that building"? And the system should be able to tell that you looked on your right, use your GPS coordinates to figure out what building you're talking about. With connectivity -- the cloud connectivity go and fetch information about the building and kind of tell you, hey, give you all information about that building. That's a very simple use case that I thought of sharing that you can see sort of advanced interactions that will be enabled in the car. This use case that I mentioned is not just a pigment of my imagination. It's -- it goes into production in S-class later this year when Mercedes ships their new flagship product et cetera. So there are many other kind of interesting examples, but like I said, time doesn't allow me, but our website has all the information about various different products. This last slide here talks about our long-standing customer and partner relationships. We operate in the automotive ecosystem. Like I said, the focus of the company is transportation and mobility. And in the automotive ecosystem, pretty much every OEM on the planet is our customer. We're absolutely honored to work with almost all of them. And we also work very closely with the Tier 1s to integrate our software technology onto their head units or other platforms to take it to market to the OEMs. So that's a quick intro to Cerence. With that, I'll turn it back to Jeffrey, please.

I appreciate that, Sanjay. Definitely a helpful overview to get things started.

Maybe just topic on everyone's minds is COVID and the impact to your business. The bookings, win rate in the press releases you've had over the past 3 to 4 months have certainly been impressive. But can you just talk about what you're seeing in the overall market and the impact to the Cerence in general?

Sure. In a -- COVID hit us all in a -- early part of this year. And clearly, it's an unprecedented when we look at what's happening around us. The -- for Cerence, as a company, we had an absolute picture perfect start. If you look at our financials, our other achievements in the first couple of quarters, absolutely picture perfect start of the company. And I give that credit to a very seasoned management team that I put together to run this company. Not just -- it's -- I'm surrounded by a very talented group of individuals, and they did a fabulous job to start this company up strongly. Having said that, we started seeing some slowdown, shutdowns in China in January, February as COVID-19 was hitting us. And then as China was coming back online in late March, April, the rest of the world, which is Europe and North American was shutting down because of COVID-19. And on our business, in our last quarter, which is January, February, March quarter, we didn't really see much, much impact. If you look at our earnings, we announced a record everything. We announced record revenue, record operating margin, record adjusted EBITDA record bookings, revenue was 23% up -- adjusted EBITDA was almost 33%, 34%. But the number that I'm most proud of was our bookings number. We announced first half bookings were $533 million, which was higher than all year of 2019, right? So it was very strong for us. And that obviously goes back to our leadership on the products that was being adopted by a number of OEMs. Moving forward, we did take our guidance down for second half of this year. We did guide for the whole year previously, but we had -- we were sort of -- we were forced to take our guidance down because our customers were not guiding. They were all taking their guidance down because nobody just knew what this COVID-19 impact is going to be. So as a result, we also took our guidance down for our third and fourth quarter, which is the current quarter and the next one. We are -- our fiscal year October to September, basically. And so if you look at our revenue profile, about half of our revenue is not tied to AUTOSAR. It's independent and we're quite okay with that. The second -- the other half of our revenue is tied to AUTOSAR. And it's anybody's guess right now as to kind of how that's going to fluctuate in the current quarter and the coming quarter. There are some interesting positive early signs, which were more positive. As China was opening, I started getting reports that there are lines in Wuhan to buy a new car. And I was completely -- I said, what, I don't get it, right? Why would in this situation, people will be lining up to buy a new car because that would be the last thing that I was thinking at that time, people would be thinking about. But the reason was that with virus still being around us, people don't want to use shared transportation. So that was the reason why kind of there was -- if you look at the early monthly results out of China, it is still down from last year, right? But it's lesser down than what all of us thought it's going to be. There are signs in Europe and the U.S. as well. There was a recent article written in Financial Time where they were interviewing this couple out of New York who have never owned a car. And they -- forced opportunity, they got, basically, they went and bought a car, same reason, right? So how this is going to affect AUTOSAR, I don't know right now. That's the reason kind of we took our guidance down for the current and next quarter. Having said that, myself and our management team, we're heads down, very focused. We took some proactive steps to align our costs very quickly. It was really not necessary, but it was the right prudent thing for us to do. Not to really wait for the data, it's always easier to add cost than to take it out, as we all know. So in March, I kind of -- my team and I, in a very focused, thoughtful way kind of adjusted the business in case there is a longer downturn and so on and so forth. So we're feeling very comfortable with where we are. We have a very strong balance sheet. And we just -- we did a very important -- we took a very important step yesterday to do a convert offering to make a very meaningful adjustment to our capital structure, right? So moving forward, I'm just absolutely thrilled that we have a picture perfect capital structure moving forward here now. Because what we did was, we had $270 million of debt. It was a term loan B that was saddled on us as part of our spin. Thank you to Nuance. And that debt offering was led by Nuance. So it was not a great piece of paper to have on your balance sheet because it was LIBOR plus 600 basis points. It was a pretty expensive paper. And so we took a step yesterday to do a balanced swap that we are, we want to be doing in the coming days and weeks. So we're going to be retiring all of our term loan B, and replacing that with a balanced term loan A and convert altogether. And that basically kind of saves us almost 3%, 3.5% in interest, which is almost $9 million to $10 million a year in interest payments, which is absolutely a material savings. I mean, if you do EPS calculation that adds about $0.25, maybe a little more to our earnings per year, right? So that's absolutely a meaningful contribution and also puts our net structure where it should be at the start of the company.

I appreciate the detailed response, sir. One just clarification. So I think while you pulled guidance for the year, and it's very unclear, I agree on the production side. Can you talk about the comment about 10% to 15% outgrowth or growth over market that you expected. Obviously, the market forecast are a moving target, but maybe walk investors through why you're exceeding whatever the market does?

Sure. So as I said in my opening statement, we focus on the voice and related technologies and enabling the digitization and advanced interaction in the car. The adoption of these products is basically happening faster than the AUTOSAR. So if you look at last couple of years, you will see our adoption rate higher than the market. And if you look at our financial results for fiscal '19 or last 3 years, in fact, you'll see us growing, in our CAGR growth is somewhere in the [ 12% ], 13% range, while the auto industry was growing at a lower pace than that, right? So we have traditionally kind of being ahead of our -- the auto growth rates. And the reason for that basically is the adoption of these technologies.

Got it. That's certainly helpful. Maybe just as we look forward, how do we think about connected and SaaS opportunities? I think that the way you're going to continue to grow above the market is the attached rate of voice is going to continue to rise and then as connected vehicles play out, one of the additional services. One of your slides had a whole host of different things you're working on. But you've signed a bunch of orders over the past 4 to 6 months. Can you just talk about above and beyond the license revenue stream? Some specific examples of maybe features that are in the recent announcements or the Audi announcement the other day. Any additional detail and specific examples of features that you're enabling would be helpful.

Very, very good question, Jeffrey. So I'll just outline our product strategy moving forward here, in very simple words. Number one, we are focused on increasing our revenue per car, the content per car, right? We're -- I said that in the Analyst Day in February that we see that revenue per car are doubling for us. And the reason for that is basically the products that some of them that I shared with you in the earlier slide. So as the voice adoption happens and we basically bring multi-modality and interactions in the car, obviously, we'll be able to charge for it and hence, kind of increase our revenue per car. So 1 KPI that me and my management team are very focused on is basically growing the revenue per car, right? The second piece that we are really focused on is driving the penetration further. More so of our Connected Services then of our edge products in the car. The reason I say that is because the adoption of our edge products is pretty high already. And clearly, there is growth left there as well, right? But the Connected Services is very new in the car because the car is just getting connected to the Internet, right? And you and I both know what happened when we took our phone and connected that to the Internet or we took our PC and connected to the Internet, right? The whole business transformation takes place. And I see a similar journey over the next 5, 10 years for a connected vehicle platforms. And we want to kind of monetize that. And so that's number 2. Number 3, the third pillar in our strategy is what you said, which is basically some of the SaaS products that we are bringing out. And the thought there basically is very simple. That we have -- today, we are attached to a new car shipment, right? That's great because once you get designed into a platform, I call it -- a lot of people in the software space are -- they love ARR, annual recurring revenue, right? I call our current business, also an ARR business, which is annual repeatable revenue. Because once you're designed into a platform, we're repeatable across multiple car lines and over 3 to 5 years minimum, right? So once you get in, you basically kind of enjoy the repeatable nature of our revenue. But we are also trying to -- but what we don't monetize is the life of the car. We are attached to the new car shipment today. But what we are changing basically is that we have a very nice installed base of 300-plus million cars. And they live on the roads for, on an average, 7 to 10 years minimum, right? And we want to come up with products that are layered on top of our existing platform to monetize a SaaS annual kind of recurring revenue. So we are very focused on that. We announced our first product in a product called Car Life, which basically improves the driver ownership experience of the car. And if I may take a minute to explain it, what this product does. Basically it starts with when the car is made, you want to basically sell the car. And today, when you go and try to do a test drive and buy a car, you have a salesmen who typically knows 1/3 of the features of the car. Won't it be great that there is a virtual sales assistant, sitting with you in the car through the voice channel, and basically kind of telling you about the features of the car, right? And so through the voice and our connected platform, we basically kind of deliver that virtual sales assistant to the driver. Once the driver -- once the consumer has decided to buy the car, the first thing that the consumer has to do is to onboard a driver which is sort of like a quick start guide, right? To kind of tell you about the car. Again, we can do that through voice. I have been driving as a consumer last 40 plus years, I probably owned about [15 ] new cars in my life. Every time I buy a new car, I'm all excited that I'm going to read about this car, read the manuals, watch the videos. How many times have I done that? 0, 0, right? But I would love to have a -- while I'm driving, a system that basically kind of helps me learn about the car. I can give it comments like," Hey Mercedes, tell me about my infotainment system, "Hey Mercedes, how do I measure tire pressure?" What's this like about? What's that about, right? So AI-powered Q&A module a question-and-answer model that is very intelligent and is able to kind of pull the information out and present it to the driver, as a driver is learning and onboarding and driving the car, right? And the last phase of this product is basically scheduling service. It's -- in this day and age, I mean just -- if you think about how we scheduled services like in our dark ages, right? You kind of go and find the 800 number of your dealer, you call them, they see you're -- the slots that they have, and you take the car for service, and you know half of the time they don't even have the parts for what the car is needed, what the service is needed, right? So it's a completely very inefficient system, a connected vehicle through the DTC codes knows what services are due, what parts are needed for that service. And why can't that be all automated through a simple voice command, which basically says, "Hey Mercedes, am I due for service"? "Yes, you are". "Can you please schedule it?" And all back end nonsense is taken care of and kind of the services schedule. So those are the things that we are trying to kind of bring to improve the ownership experience of the car.

That's helpful. We've got about 10 minutes left. Anyone in the audience that has a question, feel free to shoot me an e-mail. It's [email protected], and I can ask it anonymously on your behalf. But there are 2 topics, Sanjay, that I was hoping to squeeze in, in the remaining time, and then we'll see if there's any questions from the audience as well. One is just cognitive arbitration and many -- I just launched coverage of you folks a few weeks ago, and there's still a contingent of investors that think Amazon and Google will dominate the car. And certainly, there is a presence for digital assistance in the future. But can you just talk about the different vectors that come into arbitration, enables whether it's things embedded in the car or the cloud through the Mercedes or BMW or Audi user experience relative to what can be done in the cloud. That was part one. And then maybe you can work in the answer. There's been in a post COVID environment, a tremendous amount of interest it sounds like in cars. But across society around contactless payment. So one of the things on your slides was Cerence Pay. Can you talk about how voice can enable payments? And in particular how Cerence is able to monetize that? Is that an additional revenue stream on your journey of doubling your revenue? So if you can address those two, and then I'll monitor my e-mail and see if there are any questions.

So firstly, we absolutely think there is a place for the big tech companies in the car, whether it's Google, Amazon, Apple, Microsoft or others outside North America or Europe, companies like Alibaba, Baidu, Tencent or if I'm a consumer in Russia, Yandex or others, right? So we think that place is a coexistence, where the OEM gets to define the experience and own the data and also the arbitration to 1 or multiple consumer tech companies. So that's the architecture that we are implementing, using what we call cognitive arbitration. So cognitive arbitration in a very simple world is like a voice router, which basically does the arbitration not just based on wake up word, but based on intent, based on what the user wants to do, right? So it's intelligent voice router, basically. So for example, I'm driving in the car, and I say, "Hey Mercedes, switch on my car lights". And of course, the system knows that, that command is for switching the car lights and takes care of that. But then I say, "Hey Mercedes, switch on my porch lights". If I say that, it should be able to go in arbitration [indiscernible], let's say, the porch lights, which are being controlled by Alexa to be able to do that or I say, "Hey Mercedes, switch on my bedroom lights" and in that scenario, the bedroom may be controlled by Google Home. Right? So if you think about a consumer, if you think about yourself, for example, Jeff or Jeffrey or anybody else here in the audience, as a consumer, you would get the answer, very simply that you are not tied to 1 single consumer tech company. If I think about myself, every single day, I use Apple devices and services, every day, I use Google services, every day, I use Amazon services, every day, I use Microsoft calendaring, outlook and other services. Right? And what I want as a consumer is I want car not to be a separate digital island. I want car to be an extension of my digital life. Whatever my digital life is, I just want car to be seamless and extend my digital life while I'm in the car. That's what I want, right? And so the architecture that we are trying to implement is to enable OEMs to extend the digital life of a consumer in the car. That's it. Very simple. And to do that, obviously, there is a role that we play using our products, but there is a clear role that tech companies also play with us, right? So that's kind of -- and again, in U.S., we talk about Google and Amazon and Apple, et cetera. But if I'm a consumer sitting in China, and remember, maximum number of cars are shipped to China, not U.S. I don't care about Google or Amazon or Apple. I care about Alibaba and Tencent and Baidu, right? And so that's what I want. I don't Apple or Google, right? And from a global OEM standpoint, they want to basically have an architecture where they can basically ship their cars into different markets, right? And that's what we do. On payments, when you're driving, there are 5 things that you do that forces you to touch your wallet, okay? Number one, is you pay for fuel. Number two, you pay for parking. Number 3, you pay for tolls. Number 4, you drive through, buy a coffee, buy a burger, whatever. Number 5, you make restaurant and other reservations, right? So these are the 5 top use cases. What we are trying to basically do is to kind of voice enable these use cases, these payments through Cerence. And the core of this technology is voice biometrics. Kind of like your fingerprints or your face ID, right? So just if you have a face ID or fingerprint, you authenticate you, your password user, whatever you want to say, whatever security that you use. We have a similar and more secure way of kind of ID-ing a user using voice biometrics. So that's part of our core product portfolio, right? And so we use voice biometrics to kind of authenticate a user. And so the use case would be that you drive to a pump and you say, "Hey Mercedes, pay $50 on pump 15". That's it. You walk out, pull the gas pump. And everything else is taking care of. You don't have to touch anything, you don't have to swipe a card, add your ZIP codes or your pass codes or your NFC payments or any of that stuff, it's all kind of voice enabled. And similarly, you can do use cases like, "Hey Mercedes, take me from [indiscernible] to San Francisco. And I would like to stop to get a cup of coffee and find me a parking that's a parked -- that's a covered parking spot". And the system should do all that stuff, magically in the back, right? And that's -- those are the sort of advanced use cases that we are working on.

That's helpful. Specific examples, I think, are -- resonate better with investors than some of the higher level conceptual stuff. I did have one. If you have time, maybe we can run a few minutes over, but one question that came in from an investor. So I will just read it to you. Are there any emerging technologies that have the ability to fundamentally accelerate your value proposition to OEMs and drivers, such as edge, AI, 5G, et cetera? That's a question mark after that. Do you expect this penetration story to be relatively linear? Or is there an S-curve adoption lurking in the future?

So great question. I think a connected vehicle clearly accelerates the voice adoption. Our edge products are very intelligent, but they become much, much more intelligent and in some of the use cases that I shared when the car is connected, right? Remember, unlike your phone, our platform is deeply integrated in the car. So we're connected with the 200 sensors, all the car data and all that stuff, right? So we know everything about the car because of where we sit, right? In the car technology stack. And the use case has become much, much more interesting and useful to the driver as the car gets connected. 5G clearly helps that even more because of lower latency, higher bandwidth, although even with 4G kind of for the use cases that we are enabling because voice is not a bandwidth hungry kind of technology, unlike video or autonomous driving. So we are good with connectivity, 4G or 5G. 5G clearly helps latency and all that stuff, right? And the S-curve in our connected services adoption and these use cases adoption basically happens more as the car gets more connected.

That's helpful. Thank you both for participating and everyone in the audience for tuning in. Certainly, you can reach out to Ritch with any questions directly to Cerence or myself, either of us are happy to help. And thanks again. Everybody stay safe. Take care.

Thank you so much.