Cerence Inc. (CRNC) Earnings Call Transcript & Summary

So good morning, everybody. My name is Raji Gill. I'm the Managing Director here at Needham & Company where I cover the global semiconductor industry and automotive technology. So as part of our conference today, we're very pleased to have Cerence presenting with us. We have Sanjay Dhawan, the Chief Executive Officer for Cerence; as well as Richard Yerganian, the Vice President of Investor Relations. Mr. Dhawan has been the CEO of Nuance in October of 2019, which was spun off from Nuance. Previously, he was the Head of the Automotive business at Nuance. The format of the call is going to be Sanjay will go through the presentation, which has a lot of great slides, for about 35 -- about 30 to 30 -- 35 minutes, and then we'll leave the last 10 to 15 minutes for Q&A. So let me hand it over to Sanjay.

Sure. Thank you, Raj. Good morning, everyone. Very good morning, early morning for me here from San Francisco Bay Area, nice and early at 5:15 a.m. So very warm welcome to all of you and thank you for attending. Let's move to Slide 3, please, Rich. The company, Cerence, as Raj said, was spun out of Nuance. Nuance had 3 lines of businesses which was in Healthcare, Enterprise and Auto. Nuance Auto was spun out into an independent company called -- and we called it Cerence. I took the lead as the CEO of the company starting October 1. Previously, I headed -- immediately before, I was President at HARMAN, running HARMAN Connected Services, the software platform and services business at HARMAN, and was absolutely delighted to join the team here to build Cerence. As you see in the slide, our vision for the company is that we want to build products which enable safer and more enjoyable journeys for everyone in the car. We build platforms which enable human-machine interaction inside the car. So when you're sitting as a driver, we want all the drivers to have their hands on the steering wheel, eyes on the road, and we want to basically enable various interactions in the car. And so that's the focus for our company, is -- to enable that focus, we build these automotive digital platform solutions for both connected and autonomous cars. So instead of kind of me, I mean, giving you more details about our product, we thought we'll just play a quick product video for all of you. So it's a 2-, 3-minute video. So with that, let's start the video, please. [Presentation]

So as you can see in the product, this was Cerence ARK. And in this, most of the interactions were voice-based, but we don't stop there. We're working on multimodalities in our interaction mechanism where we bring computer vision, gaze, gestures and kind of how humans interact, bringing the complete modality of interactions inside the car with a simple rule of kind of making the journeys safer and more enjoyable for all the drivers. Next slide, please. This slide here basically talks about our strong heritage. Although we are a young company, as I said, we started in October of last year, we have more than 20 years of industry experience because this business basically was started inside of Nuance. So that has seen a lot of past history behind the business. There are about 325 million cars on the road with -- worldwide with our technology. Almost 2/3, 75% of our employees are R&D and service professionals. So we're about 2,000 employees, roughly 1,500 working on various different new products and also integrating these products into the automotive OEM cars. A very strong portfolio of IP. Almost 1,000, 1,200-plus patents, core patents in the voice technology are owned by Cerence. One element that people don't realize about us is that when we bring the automatic speech recognition and also the natural understanding that you saw in the car, we just don't do it in 1 language, we do it in 70-plus global languages, right? So if I'm a global OEM making a car, obviously I want to put technology into my car, which I can ship into various different countries. So language support is a very important element in this business. And we are proud to basically support maximum number of languages as compared to anybody else. So 70-plus languages supported, and you can only imagine kind of getting not just the speech recognition and accent and all that stuff detection right but then also the natural understanding of what each person is saying in different language right in 70-plus languages. This is a very tough AI problem to solve. We're very proud of our engineering team who basically solves this problem. Almost all automotive OEMs are our customers, and I'll talk a little bit more about that in a future slide. Next slide, please. So this slide here basically talks about our core strengths as a company. In summary, number one, we are -- we provide the human machine interface software products. We're a software company, and we're basically enabling the consumer to extend his or her digital life inside the car. We'll talk a little bit more about that in a subsequent slide here. We're a global leader in these solutions that we provide to all automotive OEMs. We work with pretty much every single one of the automotive OEM and the whole big ecosystem of Tier 1s. We'll touch upon that in a subsequent slide. We're fairly well positioned strategically because we enable the OEMs to own the experience, et cetera, and we'll talk about that. And then we'll share with you in the subsequent slides our business model and how the various trends in the industry are helping us with our future growth. And finally, and I'll talk a little bit about our financial profile as well. Next slide, please. So this slide here talks about our product portfolio. You saw the demo. I won't go too much into detail but just at a high level. Basically, you can think of our products being split into 2 set of edge products which work inside the car. They do the magic of kind of doing the voice and other interactions in the car. We're heavily integrated with the car sensors. We're heavily integrated with the car data that gets produced inside the car because we're sitting inside the head unit of a car. Why this is important? Because this integration enables us to provide user experiences which are fairly advanced. So for example, later on this year, you'll see us with our -- some advanced products into the new S-Class from Mercedes. And you can do interactions like while you're driving, you look on your right and you say, hey, Mercedes, what's this building? And the gaze detection looks -- tells us that this -- we're looking on the right and the voice interaction basically brings in the response back. Not just that, we're integrated with the seat sensors. So when we are pulling a navigation path, how we can basically tell whether we should use the high-occupancy HOV lanes or not because we know how many occupants are in the car, for example. So that's -- these are the products sitting on the edge side. We have a set of products which are connected in the cloud. Our architecture is very hybrid, meaning we will work independently if there is no cloud connectivity available. Because, let's say, you are in the basement of a parking lot and there is no cloud available, or sometimes when you're driving, you lose connectivity to the Internet. We want to make sure that we provide near full functionality in that scenario, but then we also work with when we are in the cloud as well. Rich, something went wrong on the slide show. Yes. Thank you so much. Next slide, please. Thank you. This slide here basically talks about our -- us being a global leader. Like I said, about 325-plus million cars shipped with our products. We ship in about 1 out of 2 new cars every day. We -- in a typical quarter, we basically ship on 10 million to 12 million cars every quarter. So somewhere in the 40 million to 50 million cars a year ship with our products. So fairly good kind of leadership there. As you can see, pretty much all major OEMs are our customers, and we work with all the Tier 1s as well who are basically building these head units. And typically, an automotive OEM selects us. We announced Ford, for example, the next-gen Ford, which was Ford SYNC 4, goes live later this month, where all the Ford vehicles will have our software. And to enable that, we work with -- very closely with the Tier 1 suppliers which are providing the head units to Ford, for example. Next slide, please. Thank you. Strategically, as I said, we're very well positioned. Our philosophy basically is that our job is -- as a company is to provide a white label solution to our automotive OEMS. We think the human-machine interaction inside the car is the soul of the car, and it's a digital soul. And the OEM wants to control the experience, and the OEM also wants to control the data to learn about what the users are doing in the car and also to participate in some monetization that may be possible in the future. So that's our job, to enable it. But we also work very closely with the high -- the consumer tech companies because what customers basically want is they want our -- they want their digital life to be extended in the car. But consumers don't want a car to be a separate digital island, they want car to be just an extension of the -- their digital life. So when I -- as a consumer, when I come in the car, I just want it to be seamless so that I can tell the car to then do the functions that you saw that we can do with our software. But I can also then extend my interactions outside the car. So I can say things like, hey, Mercedes, turn on my porch light. Like my porch lights are controlled by Google Home or by Alexa or by Apple Home. Or if I'm a consumer sitting in China and I use Alibaba or Tencent or Baidu, I know I should be able to bridge to that. Or if I'm a consumer sitting in Russia, I will not use Amazon or Google, I use Yandex and I should be able to kind of control that. So we have, part of our platform, a product called cognitive arbitration, which basically is an intelligent voice router that extends the -- extends our platform from inside the car to the outside big ecosystem. We do have some niche players that we compete with. I always say to my team competition kind of makes us best as a company and we absolutely welcome the competition. And you can see in the bottom right of the slide some of the very capable competitors that we compete with. We have no problems competing as long as we win all the time. But next slide, please. Rich, do you want to take this?

Sure. The -- so there's a lot of trends that are going on in the industry. And certainly, that is what's driving our development, our strategic direction. And Sanjay has touched on a number of those like being able to extend your -- the digital life from outside the car to inside the car. There are trends where, moving forward, there'll be over-the-air updates, which will allow us to update the technology on an ongoing basis. That's just starting now. Certainly, what we look to do is leverage the hardware inside the car to provide the most user-centric HMI or human-machine interaction. That's the advantage that we bring to the table with our solution, is that we are very much embedded inside the head unit, which gives us the ability to leverage all of the sensors and cameras and microphones inside the car into a much richer, fuller experience. And that's where it all ends up, in creating that brand-aligned user experience by leveraging all this technology for the consumer, for our OEMs' consumer. What -- we talked to -- a lot about the -- our ability to grow faster than the auto SaaR at a higher percentage rate, 10 to 15 points better than the auto SaaR, and this slide here describes a lot of the reason why we're able to do that. And it relates to the penetration of the technology, getting into more and more cars. As we look to -- back to 2018, there were about 59% of cars on the -- that were being manufactured that have the ability to have a voice assistant in them. Of that 59%, our share is roughly 80%. So a very, very high market share. That's been growing at a pretty steady rate, and we project by 2023, about 85% of cars are going to have that type of technology in them. And similarly on the connected side, which is now where you need to exit the car to get -- service the request of the driver, you need to go up to the cloud, there were only 12% of cars in 2018. And at that point, our estimate is we had about 50% market share. This is a faster-growing part of the technology, growing to about 50% by 2023 as more and more cars are getting this technology. And so this is where -- this has been a big secular tailwind for our business and a good reason why we're able to grow at that 10 to 15 points higher than SaaR. And we have very strong growth. Our first quarter was $86 million -- Second quarter was $86 million in revenues, very strong growth over previous year. We're continuing to take advantage of that secular tailwind. We're continuing to have a very high win rate in terms of opportunities that we have to compete in. And the interesting thing is when we announce a contract, like we announced that we have $533 million of bookings for the first half of fiscal year '20, which was all -- or more than all of fiscal year '19, the interesting thing about most of those bookings are that they won't start driving license revenue for us for, on average, about 2 years from now. And then we've kind of coined this term ourselves that -- a lot of people talk about annual recurring revenue. We refer to annual repeating revenue because once that car starts shipping, we're getting repeating revenue from that contract for the next 4 to 5 years because it's a -- it's a platform decision. So there's a major upgrade and then there's subsequent minor upgrades in the next 3 to 4 years. So during that whole period, we're generating license revenue from that business. So that $533 million on top of the very strong backlog that we already have is very key to our forward-looking business. And then we're a software company. And as a result, our results, you would see that we deliver very strong financial results also. The mix of our business is primarily the license business, which is the edge or in-car capability is the primary product line for us. We also have the connected services, which is a growing part of our business; and the professional services, which is the engineers that, during that 2-year period before we start generating license revenue, these are the engineers that are working with our customers to customize and integrate our software into the new car design. And so we get compensated for that work as it gets achieved. So in our fiscal year, our second quarter, we had -- again, we continued the momentum that we've seen from fiscal year '19, highest revenue in the company's history. We already talked about the bookings. We exceeded or met all the goals. You can see the very strong year-over-year growth in the key metrics. And in addition, we announced some very key wins for the company: Geely, who also owns Volvo; Bean Tech; Fiat-Chrysler. And it's -- the momentum for the company is just continuing. And fortunately, we really didn't see much of a -- we saw a little bit of an effect from the COVID environment in our Q2, but even with that, we still have the highest revenue in the company's history. And the other thing that I'll note is that from a sales funnel perspective, that those efforts aren't slowing down. The professional services work, that we're not slowing down. So that has minimal impact by COVID. And the same thing with our connected services because that is an amortization of revenue of cars that have already shipped. The impact to that is relatively minor. The COVID sensitivity is on the license side. So this is how we report on a quarterly basis the various revenue streams. And like I said, license is the one that is most susceptible, but you can see strong year-over-year growth. Connected services, strong year-over-year growth as well as professional services. And the key thing about the professional services is that -- it tends to be a leading indicator of future license revenues because, again, these are the people that are working on the new car designs to get the work done to get those cars to start production. And so as that line item reports strong growth, that's a good indicator of future growth on the license side and the connected service side. From a balance sheet perspective, we have very strong balance sheet. We've already made adjustments to the business in the environment of COVID to minimize any negative impact from that unfortunate pandemic, results in about $12 million of second half OpEx savings. We've reduced our CapEx spend. We've done some executive pay reductions. At this point, based on the IHS data in terms of their forecast of the market, we think we've made all the adjustments. But obviously, if things change again, then we certainly will revisit that. When the company was launched, we did have, as a parting gift from Nuance, a $270 million term loan B that was at a very high interest rate. It was at LIBOR plus 600 basis points. So one of the things that was high on the management team's list to do was to refinance that debt. And that's something that we accomplished last week where we did a hybrid solution, which was a combination of changing -- of swapping out the term loan B using a convertible bond as well as a term loan A, which is in process. That's not complete yet, but that's in process. It was part of the whole concept behind it. So what you see here is sort of in the first 2 columns is the term loan B, what the actuals were for our first 6 months or year-to-date, and then what the change would have been had the convert and term loan A already been in place. And you can see the annualized savings of $11.3 million from cash interest expense. That's real strong savings. And on the bottom part of the slide, you can see from a net income basis, both on GAAP and especially non-GAAP, you can see that it would annualize to -- at around $0.23 a share have we already had the convert and term loan A in place. So with this change, we've really fixed what we thought was a -- with the -- something with the balance sheet that, from the term loan B, was something that was more expensive than it should have been. And that's basically it, the presentation. So I'll hand it back over to Sanjay or Raj.

Yes. So thank you, Rich. So in closing, a fairly strong start for the business since our spin. I have led spins before in 2006. A company that I led was a KKR-owned spin, so I'm kind of very familiar with spins. And all I can tell you is that I think our stock has been almost picture perfect as a company. Obviously, COVID-19 hit us, and we as a management team are doing our best to kind of make sure that even in those scenarios, we would deliver the results that the investors expect us to. So with that, thank you so much for attending, and I'll pass back to Raj.

Thank you, Sanjay. We have about 10 minutes left. Any questions that investors have, there's a dashboard below that you can ask questions, and I'll ask them on your behalf. But Sanjay, if we could first start with 2 big recent wins, particularly your long-term partnership with Audi on the AG Connect platform (sic) [ Audi Connect platform ] as well as the Ford SYNC 4 platform. I want to get a sense regarding Audi, your -- what offerings are you providing on the Audi Connect platform? What was Audi using before, if anything? And so what value in terms of services that they're adopting from your offering? And then also on the Ford SYNC 4 side, maybe describe the potential unit opportunity there as well because I think those are kind of 2 notable wins.

Right. And so we're very fortunate to be working with both of these customers. And I think with these 2 announcements, what you'll see is a fairly -- if you look at last 3 months of our customer announcements, you'll see customers in Asia, customers in Europe and customers in U.S. kind of using our platform, which stresses on the global footprint that we have and the language coverages and so on and so forth. In case of Audi, we're very fortunate. It's a partnership that has been there for a long time. We announced earlier a couple of very large bookings orders. We didn't name the customers, but people can kind of connect it. We said a big European OEM. And we're basically getting standardized across all the brands, across various different group brands that Audi is part of, right? As you know, Audi is part of Volkswagen Group that has all the other various different brands like Porsche, SKODA and Volkswagen and Audi and so on. And working with OEMs like them in this case, to answer your question specifically, it's a complete suite of products both on the embedded side with tight integration with the rest of the Audi [ received ] platforms and MIB platforms and also our cloud portfolio, which basically kind of provides a full suite of interactions inside the car. We're also -- although we have not explicitly announced that yet, and hopefully in the coming future, but if you look at some of our products like Car Life that we announced at CES, which basically enables very interesting user interaction, which you can ask the system about the information about the car, so you can basically say, tell me about my infotainment system, how do I measure the tire pressures, what does this maintenance light means, what am I supposed to do. So you can ask these natural questions, which typically you have a user manual sitting somewhere in the back of your trunk and you never open it and you always wonder kind of how to do certain things in the car. We bring those sort of interactions as well to Audi. Ford SYNC 4 is the fourth generation of Ford's infotainment and digital architecture that, as I said, they'll be launching with the Ford F150 starting this month, the month of June. That's the reason we kind of made this announcement with Ford, and we're absolutely delighted to be part of that platform as well.

So just quickly on the Audi design. So just so I understand it, it's both for in-car as well as cloud connected?

That's correct.

Okay. Sounds like -- so you have both. Two parts of your major businesses are using that. And if you could maybe talk a little bit about some of your recent -- your new potential product offerings. You have this multimodal emotional AI technology that's able to track several different emotions. How are you looking at kind of complementing voice with other multimodal technologies? And where -- and how can you leverage that technology with things like in-cabin monitoring and other applications?

Sure. Very important question. The first piece of our, obviously, product offering is the basic interactions, right? So we showed the demos and all that stuff. The next step is basically to kind of use the AI technology to add more kind of human interaction. So for example, with -- when -- through our voice, we can -- we have voice biometry. So we can actually authenticate and identify a user. So we can basically say, okay, right now, Sanjay is speaking versus Raj's voice or somebody else's voice. So you can bring personalization in the car. You can bring -- for payment purposes, you can bring authentication, no different than using your fingerprint or other biometry to authenticate the user. Similarly, we use voice biometric to authenticate a user. And so that's the other piece. We can detect emotions of what mood the user is in, right? So is he sad? Is he happy? Is -- other emotions. Is he stressful? Just absolutely amazing. And as I came in as a new CEO of the company and I was kind of interacting, I'm an engineer myself, with my team to kind of really understand our portfolio and go deep, it's quite amazing how much technology advancements we have in these areas. But the one that -- one use case that I'm very excited about is basically beyond voice, which is around voice biometry or emotions or other interactions. We -- by the way, we can also bring another level of personalization. We announced a product called voice cloning. So we can clone a voice. I can take a sample of 4 to 6 seconds from a user. And then after that, basically all interactions will be cloned. So the way we plan to use in the car basically is that instead of a car -- let's say I'm drowsy. Instead of just some random voice coming in telling me, hey, Sanjay, you're drowsy, if my daughter's voice comes and basically says, hey, dad, you're drowsy, be careful, my response is going to be very different than some random voice kind of coming and telling me that I'm drowsy, right? So there is a lot of safety and personalization elements, right, that we bring with these multimodality. But the trend in the space is to bring computer vision also. And you basically kind of use that to do gaze, the detection, right? And I mentioned earlier the S-Class piece. We're working with Mercedes, which is also a very close partner of ours. And we're actually -- through -- they -- you have started hearing about the launch of the new S-Class. There are a number of reports that have been published on that, and we'll be kind of showcasing some of our advanced interactions in that car. One example that I used earlier, which is kind of look on your right and you basically say, hey, Mercedes, what's this building and -- or sort of that interactions.

So Rich, you had mentioned that professional services is a leading indicator for the licensing business. I was wondering if you -- and you saw it was an 88% year-over-year growth in professional Services, and that's becoming a larger percentage of your sales. So can you kind of maybe elaborate further in terms of what the read-through you're seeing in terms of the adoption rates, the attach rates, this growth in professional services is telling you as part of the overall market size and your technology differentiation?

Yes. And I think it does get back to the penetration story that I mentioned earlier, where there's more and more cars -- as Sanjay referenced, the 2 big orders that we had. It's interesting with that customer because that customer is extending the technology to more brands and more makes and models than they ever had before. So what that does is that requires more work on our part to help them accomplish that and do it in the way that they want. So the more of the projects that we're working on, and therefore, obviously, the more revenue that's generated there, that is going to directly lead to additional license revenue when those projects are completed.

All right. Great. I think we're bumping up against our time, but -- so we'll stop here. Thank you so much, Sanjay and Rich. Thanks, everyone, as well. Great story and congrats on all the recent momentum.

Thank you. Thank you so much, Raj. Thanks for inviting us. Thank you, everyone.

Yes. Thank you.

Thank you.

Bye now.