Cerence Inc. (CRNC) Earnings Call Transcript & Summary

Good afternoon, everybody, and thank you for joining us for this session with Cerence as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the Senior U.S. Autos Analyst at Deutsche Bank. Cerence is a market-leading automotive software company, specializing in cognitive assistance solutions to increase the connectivity between vehicles, passengers, the cloud and the physical world around them. We're very pleased to host with us this afternoon Cerence's CEO, Sanjay Dhawan; as well as Head of Investor Relations, Rich Yerganian for a discussion. The format of this session will be a presentation from the company, using some of the slides that should be available in your webcast window, followed by a Q&A session with questions from myself as well as all of you on the call. [Operator Instructions] I highly encourage you to do so and get involved in this discussion. Only I will see your questions, and I will ask them on this call without mentioning your name or affiliation. So with that, I'm going to hand it over to Sanjay. Thank you again for being with us, and over to you.

No, thank you. Thank you so much, and thank you to everyone joining this call. We appreciate your interest in spending the time learning about our company. Cerence was started as an independent company on October 1, 2019, so last year. And that's when I joined the company as its CEO and put a management team, Board and so on -- and other infrastructure together to spin the company out. We were public-to-public spin. We were -- Cerence used to be a auto division inside Nuance. And the Board of Nuance took a decision to spin the company out as an independent company, and selected me to lead it. So I'm absolutely thrilled to be running the business, what's a very interesting and unique business proposition that I want to share with all of you. So let me start with Slide 3, please. On Slide 3, you will basically see our vision and mission as a company. We're a AI software company. We build software that helps the driver of a car interact with the car in a safe, secure and enjoyable fashion. So this is basically AI-enabled software that's embedded both inside the car and also in the cloud. And we basically empower the complete automotive ecosystem to work with our software. If I go to Slide 4, we basically -- although we're a new company, as I said, we were made independent as of October 1, 2019. But we have a strong heritage. We have been working in this space for the last 20-plus years. We have a pretty big installed base of almost 325 million cars. We ship on -- anywhere between 10 million to 12 million cars a quarter, so almost 42 million to 50 million cars a year get shipped with our technology, which is -- almost 1 in 2 new car ships with Cerence software. We -- the company is about 2,000 employees, more than 3/4 of the employees are R&D and engineers, basically. A very strong portfolio of IT patents, a very rich portfolio, since Cerence has been in this space for a long time. And finally, the human machine interaction that we enable in the car, the core to that interaction is our voice platform, our cognitive assistant platform and that platform supports almost 70-plus global languages. This is hard to do because trying to kind of do speech recognition, natural language understanding and all the related kind of interactions in 70-plus languages is a very hard proposition to implement in AI, and that's what we do. Almost all of the automotive OEMs and Tier 1's are partners of Cerence. Moving on to Slide 5, please. This slide here sort of talks about our key highlights as a company. I'll just quickly summarize it on this page, and then we'll cover each of them one by one as well. We, as I said earlier, we're a provider of AI software platform, which basically enabled the interaction for the driver sitting in the car. So this includes the voice interaction, this includes other modality of interactions, and I'll cover that in a little bit more detail in a slide -- after this slide. The second point I want to make is that we are a global leader in the voice powered assistance space in the automotive sector. We are pretty much -- all the major automotive OEMs and Tier 1 suppliers are our customers. And like I said earlier, we ship in 1 in 2 cars, and so that's a pretty strong position to be in, and we're very proud and working hard to maintain and grow that. We have a strong strategic position as well. The automotive industry, the car is going through a lot of changes in terms of its architecture because the car is getting more digital and car is getting more connected. And as a result of these big trends, the whole architecture of the automotive digital footprint is changing, and we have a very strategic position, where we want to be the apple of the user interactions in the car, and we'll talk more about this in a second. We have a business model that has strong support for growth, by -- support by some secular trends and increasing of the penetration of our product. We'll cover that in a little bit more detail later as well. And finally, we'll share with you a few slides on our financial profile with regards to backlog, visibility, bookings, recent -- results of the last quarter, et cetera. So let's dig a little bit more deeper now on Slide 6, please. This slide here basically kind of talks about various components of our platform. We have part of our products, which are running inside the car, we call them edge product. There are parts of our products, which are basically based in the cloud. And we call these products connected products. And then we have professional services, which basically tie these products together into the bigger kind of software ecosystems of the car. This is a market leading platform. It won various different awards over the years. And ultimately, kind of, it shines very strongly because of its hybrid architecture, because in a car, there would be cases when you're driving and you don't have cloud coverage, so you basically want your software platform, which is enabling safer, more enjoyable drive for the driver, to be always available, even if there is no cloud connectivity. Many times when you are parked inside the basement of a tall building, you don't have any cloud coverage or when you're driving there are spots when you don't have cloud coverage. But in all of such scenarios, you still want the product to work, and that is the architecture that we are very, very well known for. Let's move on to Slide 7, please. So this slide here basically talks about our customers and partners. Like I said in my opening statement, pretty much all OEMS, all automobile OEMs are our customers. You can see some of them on the right-hand side of this chart. We also work very closely with the Tier 1 suppliers to these OEMs. So all the major Tier 1 suppliers like my previous company, HARMAN or others like Aptiv or Panasonic or Bosch or Continental, et cetera, are all customer partners of ours, where we work really closely on their hardware platforms to take our software into the OEMs. The thing that's unique about us is that our business model is very tuned to support the OEM. OEM wants to control the brand experience that they deliver through these user interactions in the car. So when a user sits in a car and says, "Hey, Mercedes, do this or do that." You want to make sure that there is a certain brand experience that the driver experiences. And that is what we do through our platform, we enable that for the OEM. We also let the OEM maintain the control of all the data. The -- through the visibility of the data. And OEM is able to see what the customer is doing in the car, what functions they're using, what's the -- where they're having trouble and so on and so forth, that helps them design better cars. But also, more importantly, if in the future, OEM wants to monetize that data in some given way, they have that opportunity as well. So overall, the business model is very OEM-based business model, both from a brand experience and also from a data ownership and monetization standpoint. So moving on to Slide 8, please. This slide talks about our strategic position. We're very well positioned strategically. We're a trusted adviser to the OEM. We're a leader when it comes to AI-based deep learning systems, which enable these user experiences in the car. We're a leader in the core voice platform, but we combine this voice with other modalities of interaction like gaze or gesture or text or other modalities. So just like as humans, when we are talking to each other, we use our voice, but we also use our eyes and hands and so on. Similarly, we want to kind of bring similar natural interaction mechanism in the car, but we want to do it in a very safe manner for the driver. We also support this notion of seamless interoperability with the consumer tech company because we have been given a very clear feedback by thousands and thousands of consumers that they don't want a car to be a separate island of technology. They want car to be an extension to the digital life of a consumer. And the digital life of a consumer would consist of working with the big tech companies, whether it's Google, Amazon, Microsoft or Apple or others. If the consumer is based here in North America or Europe. If the consumer is based in China, they want to work with the Alibaba, Baidu, Tencent. Or if the consumer is based in Russia, they want to work with Yandex, et cetera. Hence, as I said on Slide 8 on the upper right-hand side, the architecture that we are building in our -- and the philosophy that we have in our company is that we want to basically extend and make the car as an extension to the digital life of a consumer. And we want to do that by coexisting with the large tech companies. And that's what our products basically support. We do have some niche competitors, companies like SoundHound, they are based in Silicon Valley, or iFlytek based in China. These are -- we welcome competition. We -- I always believe competition makes us all good, and we welcome it because most of the time we win. So we welcome it even more. So with these competitors, we do have pretty big advantage on scale and global reach. And basically a broad portfolio of products with a broad portfolio of compatible languages, which helps our OEM customers kind of work with one partner and then deploy that product across hundreds of countries. So with that, I'm going to ask my colleague, Rich, to step in now, and slide -- start with Slide 9, talk about our business model and the trends that support the growth. Rich?

Thank you, Sanjay. So certainly, we're all looking beyond the near-term headwinds provided by COVID. And what we see is a number of secular trends that are really driving -- not only increasing penetration, but also setting the direction that the company is going in terms of the products and technologies that we're developing. And when you put it all together, and when you look at these different aspects of these trends, the goal is to create, as Sanjay mentioned early on, an IOS-like experience with inside the car. And there's a number of factors that can lead to that. Certainly, one of them is being able to take advantage of the hardware inside the car, all the various sensors, cameras and microphones, so not just relying on the cloud, but really relying on the hardware inside the car to create that richer, fuller, safer experience for the driver. And of course, the cars in this day and age, a digital part of the car is becoming the soul of the car. And it's very important to the OEMs to have that experience really aligned to their brand. And that's why they're spending the large amounts of money on developing this type of technology and these user experiences and putting top level executives in charge of this aspect of the car because it is such an important brand differentiator from one carmaker to another. And then of course, there's -- as Sanjay mentioned earlier as well, the whole idea of having a seamless transition from -- of your digital life from outside the car to inside the car. And as we all use multiple different consumer tech or various Internet-based services, we want that to seamlessly transition inside the car, and that's a big role that we play in making that happen. And then, of course, the other trend over the longer-term is continuous updates and enhancements, even a separation of the hardware and software that will allow software updates on an ongoing basis and not necessarily tied to any particular hardware. So if we go to the next slide, Slide 10. One of the reasons that the company has been able to grow, we commented on our last conference call, 10 to 15 percentage points better than SaaR growth, is -- a lot of it is related to this 1 slide here, which talks about the increasing penetration of the technology into more and more cars. And so if we look at 2018, there were 59% of global production that have the ability to have a voice product in it or edge product in it. Of that 59%, we had approximately 80% market share. That's been growing on a pretty linear rate. And as we project out to 2023, we expect that penetration of that technology to be up in the 85% range. And so that's just a natural progression of more and more cars and mix and models having that technology in it. At the same time, on the connected services part of the business, there were only 12% of cars in 2018 that had the native ability to connect to the cloud for the commercial-type services that we're talking about. And so that's expected to grow to 50% by '23. So a much steeper growth curve there. Not as linear. A more accelerated curve for that part of the market. Of that 12% in 2018, we had 50% -- roughly 50% share. So about half the cars that had that capability went out with our technology. In general, we ship somewhere between 45 million and 50 million cars a year with our technology. So it's a very large installed base and it continues to grow as each year goes by. So if we go to Slide 11. Slide 11, just review some of the various financial aspects of the company. So as I mentioned, we've been growing at 10% to 15% better than SaaR. If you look over the last 5 years, we've kind of held that. We had a very strong backlog and very quickly when we announce a booking or a contract win that typically doesn't generate revenue -- license revenue for us for about 2-plus years as that new car design is going through the design process. And then it repeats revenue for 3 to 4 or 5 years after that until that platform goes through another major change. So as we look at the bookings that we talked about on our last conference call, which were more in our first 6-month period of fiscal year '20 than all of fiscal year '19, most of those bookings won't really drive license revenue until we get, like I said, 2-plus years from now. So we have a very strong customer base, as Sanjay mentioned, we have business with almost all of the car manufacturers throughout the world. And of course, we have a very profitable business, very strong EBITDA, operating margin. We are purely a software company that is focused on the transportation space. We do have 3 revenue streams, the largest being the edge or license revenue, which is a perpetual license per car. That's followed by our connected services business, which is a license for a defined service duration period. And then our professional services business, where these are the engineers that work with the customers during that design process to integrate and customize our products inside that new car design. So those -- that's where the -- any revenue we get during that design phase comes from the professional services part of the business. Slide 12. So in our most recent quarter, as I mentioned, we had record bookings, again, more during our first half than we had of all of last year. So very strong -- represents a very strong competitive position for the company. Our revenues were up year-over-year. You can see 23%, 31% non-GAAP operating margin growth and non-GAAP EPS also very strong. Equally important, several strategic wins in the quarter in standardizing our technology. And again, this just continues to play to the story of more and more makes and models are having this technology. A matter of fact, 2 of the largest contracts that we signed in the company's history were with a previous customer, but as they go through their next design phase for their next infotainment system, they've decided to roll that out to a much broader range of -- essentially all of their brands and models that's under their ownership. So that's really indicative, and just a proof point of this penetration story continuing to play out into the future. And then we also had a strategic win for one of our newer products, Cerence ARK, which is a more -- less customizable, more packaged product, targeted at more entry-level cars to be able to offer that premium voice capability. And if we go to Slide 13, this is how our revenue breaks down. We have, like the license revenue that comes in 2 forms of variable, which is basically when the car ships, we get a royalty report, and we invoice for that. There are times when automakers purchasing departments are looking for ways to get some additional discounts. So they'll approach us with a bulk purchase order of licenses. And in return, they look for additional discounts, so that makes up a portion of our business. And then we have our connected services. And you could see pretty strong growth across the board in terms of overall license, connected services and the professional services from year-over-year. So if we go to the next slide, on Slide 14, just from a -- how we deal with the current situation. We were very proactive in adjusting the business to the effects of the pandemic. We didn't see tremendous impact in our Q2, which ended March 31, but that's -- but we took actions to adjust for it, including a reduction of contractors. We do make a fair use of contractors for some of our business, workforce reduction of about 5%. We lowered CapEx from about expected $35 million of this fiscal year because of our stand up -- mainly because of our stand-up costs as being a separate company now to about $27 million and so on, executive team reductions in various expenses. From a balance sheet perspective, we're very strong. On here, you'll see a listing of a term loan B at $268 million. What we did do a couple of weeks ago is we refinanced part of that term loan B with a convert that would cover about $175 million. The banks took the extra $25 million. So it was $175 million. And then we are in the process of completing a term loan A, which will pay down the rest of that term loan B. That original debt, on Slide 15, you can see was very expensive term loan B at LIBOR plus 600 basis points. And so with the conversion into this new combination of convert and term loan A, we would have saved a very significant amount of money -- of cash interest expense in the first half of the year, an annualized approximately $11 million, resulting in $0.23 or so accretion to the earnings per share on an annualized basis. So very -- we think, a very good move in terms of reducing our cash interest expense and setting the company's balance sheet up for long-term success. So with that, I will pass it back to Sanjay.

Yes. Thank you, Rich. So folks, that's our story, a very strong start as an independent company. If you look at our first 2 quarter performance, as Rich mentioned, we're well positioned with our OEM customers in terms of delivering what I call the Apple experience inside a car that's owned by the automotive OEM. And absolutely looking forward to kind of further building this business to its next phase. So with that, I'll hand it over back for any Q&A, please.

Great. Thank you so much, Sanjay and Rich, for this great overview and presentation. [Operator Instructions] We have about 10 minutes left. So definitely feel free to send them over. So I guess just -- at your investor back in February, you had outlined a plan to double content per vehicle to $15, $20. I guess you've touched upon some of this, but how do you plan to get there? And what's the expected time line for this?

So I basically said that the time line that I was talking about in the February analyst conference is the time line of the model that we have put out, which basically goes into 2024 over the next 3 to 4 years. And during this time line, we want to basically deliver about a 15% CAGR growth and to support that 15% CAGR growth, which we've been very comfortable with, there are 3 key things that we are focused on: number one is increasing our penetration, Rich talked about that in one of the earlier slides; number 2 is increasing the average revenue per car, doubling it during that period. And we are launching -- we have launched and we'll be launching more new products which basically increase our content per car; and the third vector of growth is basically releasing certain products which are layered on top of our 325 million, 350 million installed base of the cars.

Understood. I wanted to ask a couple of questions on potential risks on the horizon. Are you worried at all by automaker? Are you seeing -- or are you worried about automaker in-sourcing cockpit solution? Is that something that is at all a trend? Or actually, based on your technology, you're seeing the opposite?

The main trend that I am seeing is the hardware and software is being decoupled in the auto industry. And what I mean by that basically is that traditionally, a car was basically built for 10-year life cycle. You have the engine, transmission, seats, interiors, the digital dashboard and so on and so forth, all designed for 10 years life, and that's it. All that is good for everything else in the car, but for the digital part of the car, consumers expect basically an architecture that allows the consumer to update, to add new functionality, to fix bugs and all that stuff. And the way that basically is done is by decoupling the hardware and software so that the software platform can evolve independently and I sort of call it the Tesla experience, right? And that is the trend that is there in the automotive industry. And for that trend to happen, the OEMs are taking more and more control of the software, meaning they don't want to just write the spec and close their eyes and kind of not be involved. They want to be more involved in the development of the stack, but it's not a trend where -- and neither do have the capability to insource everything because they know how to build the car. They are not the experts in various different digital building blocks that build the digital part of the car.

Understood. There's been some discussion on whether some of these upcoming new launches in the context of automakers trying to be more selective in how they spend their capital. If some of those future new launches or redesigns could be sort of more a revamp or refresh of the existing model. If that were to be the case, with like some mid-cycle refresh instead of launching new ones for the time being, would that have an impact on you? Or is the [ cockpit ] essentially the piece that does get refreshed, and you would still have an opportunity to bring in new technology?

I think we're independent of that. And don't see a direct impact on us.

Because you're not seeing that trend, meaning, the launches are still happening? Or are you just saying that regardless of whether it's a new -- are you saying, whether it's a new product or sort of like a refresh, you're still on?

Can you repeat the question? I think I didn't understand the question properly. Can you repeat it one more time, sorry, for me?

Sure. Yes, yes. No worries at all. There's been -- I don't know if it's a trend or not. There's been some discussion with some automakers in the context of trying to preserve capital, instead of launching new models, a completely redesigned one, by just refresh existing ones over the next couple of years or so. And so I'm curious if in that case, you would still be able to sort of like bringing a technology or if you're heavily reliant on sort of like new models essentially being launched?

Yes. As long as we are obviously designing to those models, then the answer is yes, right? It doesn't affect us. That's what I was trying to say. If we are already there in those cars. And as I told you, 1 in 2 new cars already have us. Having said that, Emmanuel, our read is that all the programs we are working on, and we are working on, I don't know, hundreds of projects right now with OEMS, right? So it's not like 1 or 2 OEMS, right? We're working with many, many OEMs on hundreds of projects as we speak right now. We don't -- we are not seeing much delays because of COVID-19. OEMs are still anxious to ship their new cars. And in fact, there's a nonscientific read, that post COVID-19 as China was opening and some other locations are opening, people are rushing to buy some new cars because they don't want to use shared transportation, right? So I'm certainly keeping my fingers crossed to -- as numbers come, that we'll see kind of what those trends are. But our pro services, which is the group that works with our OEMs to integrate our products into their next-gen platforms, have not seen any slowdowns on any of the core platforms that we are working on.

That's it. That was very encouraging and a great follow. It looks like we're fresh out of time. So Sanjay and Rich, I really want to thank you so much for participating in our conference, for giving this detailed presentation. I want to thank all the investors on the line for joining us for this presentation and, in general, for attending this conference. Hope everyone's well, and hope to talk to you soon. Thank you so much.

Thank you, Emmanuel.

Thank you.