Cerence Inc. (NASDAQ:CRNC) is a global leader in providing AI-powered virtual assistants and innovations for connected and autonomous vehicles. The company's comprehensive software platform enables automakers to deliver customized, branded virtual assistants that enhance the driving experience. With a strong foothold in the automotive industry and a focus on cutting-edge technologies, Cerence is well-positioned to navigate the challenges facing the sector.

Business Overview

Cerence's core business revolves around providing AI-powered virtual assistants and connected services to the automotive industry. The company's software platform is designed to enable automakers to deliver customized, branded virtual assistants that enhance the driving experience. Cerence's solutions are integrated into vehicles across the globe, with the company boasting a high penetration rate of 54% of global auto production.

The company's revenue is primarily generated from three sources: license revenue, connected services revenue, and professional services revenue. License revenue is derived from the sale of software licenses, while connected services revenue is generated from the subscription-based services that provide access to Cerence's cloud-connected components. Professional services revenue is earned from the company's work with customers during the design, development, and deployment phases of the vehicle model lifecycle, as well as through maintenance and enhancement projects.

Cerence's business model has been impacted by the challenges facing the automotive industry, including production delays and slowdowns due to the increasing complexity of software in vehicles, as well as macroeconomic factors such as high interest rates and lack of credit availability. These factors have resulted in a decline in the company's connected services revenue and a slower-than-anticipated ramp-up in its adjacent markets, such as two-wheeled vehicles, trucks, and AIoT.

In response to these challenges, Cerence has prioritized several key objectives to strengthen its position in the core automotive business. These include balancing the company's cost structure in line with current business levels, while ensuring the successful delivery of its generative AI and large language model (LLM) roadmap and customer commitments. The company also aims to convert the deals currently in the pipeline, including some win-back opportunities, and release several generative AI solutions into production with high end-user satisfaction.

Financials

For the fiscal year ended September 30, 2023, Cerence reported annual revenue of $294.475 million and a net loss of $56.254 million. The company's annual operating cash flow was $7.498 million, while its annual free cash flow stood at $2.374 million. These financial results reflect the company's ability to generate revenue and manage its cash flow, despite the headwinds faced by the automotive industry.

In the latest quarter, Cerence reported revenue of $67.825 million, a slight decrease from the $68.393 million reported in the same period last year. The company's license revenue increased by 15.3% to $35.527 million, driven by a $5.0 million fixed license deal related to the settlement of a customer's over-reporting of royalties. Connected services revenue, however, declined by 28.2% to $13.597 million, primarily due to the early termination of a legacy contract. Professional services revenue remained relatively flat at $18.701 million.

Gross profit for the quarter increased by 8.2% to $46.943 million, with the gross profit margin improving to 69.2% from 63.4% in the same period last year. This improvement was driven by the increase in license revenue and a decrease in cost of revenues.

Liquidity

As of March 31, 2024, Cerence had $115.2 million in cash, cash equivalents, and marketable securities, providing the company with a strong liquidity position. The company's net working capital, excluding deferred revenue and deferred costs, was $166.3 million, indicating a healthy short-term cash flow position.

Cerence's primary sources of liquidity are its cash, cash equivalents, and marketable securities, as well as the cash flows generated from its operations. The company's ability to fund future operating needs will depend on its ability to generate positive cash flows and secure additional financing, if necessary.

In June 2023, Cerence issued $210.0 million in aggregate principal amount of convertible senior notes, including $190.0 million of 1.50% Convertible Senior Notes due 2028 and $20.0 million of additional 1.50% Convertible Senior Notes due 2028. The company used a portion of the net proceeds to repurchase $87.5 million in aggregate principal amount of its existing 3.00% Convertible Senior Notes due 2025. As of March 31, 2024, the company had $278.890 million in long-term debt, with the 2028 Notes and the remaining 2025 Modified Notes accounting for the majority of this balance.

Risks and Challenges

Cerence faces several risks and challenges that could impact its future performance. The highly competitive and rapidly changing nature of the automotive industry, as well as the ongoing semiconductor shortage, could continue to affect the company's revenue and profitability. Additionally, the company's business is susceptible to adverse conditions in the global economy, including the impact of high interest rates, fuel costs, and consumer spending preferences.

The company's strategy to increase cloud services and successfully introduce new products, applications, or services, including its generative AI and LLM offerings, may not be as successful as anticipated. Escalating pricing pressures from customers and the potential cancellation or postponement of service contracts after a design win could also negatively impact Cerence's financial performance.

Furthermore, the company's reliance on a limited number of large customers and the potential loss of business from any of these customers pose significant risks. The transition to a lower level of fixed contracts, including the failure to achieve the expected predictability and growth in reported revenue, could also adversely affect Cerence's financial results.

Outlook

For the third quarter of fiscal year 2024, Cerence is guiding revenue to be between $66 million and $72 million, which includes $20 million in fixed license revenue. For the full fiscal year 2024, the company expects revenue to be between $318 million and $332 million.

Excluding the impact of any restructuring activities, Cerence expects fiscal year 2024 cash flow from operations to be in the range of $5 million to $15 million.

Looking ahead to fiscal year 2025, the company provided a framework for how to think about revenue. Assuming flat OEM production and pricing mix similar to fiscal year 2024, Cerence expects significantly less fixed license consumption in fiscal year 2025 compared to fiscal year 2024 as its past commitments continue to wind down. Additionally, the company anticipates $20 million in new fixed licenses in fiscal year 2025 and very modest growth in its run-rate connected services, which could result in mid-single-digit growth off the new estimated run-rate revenue of $238 million for fiscal year 2024.

Cerence's management emphasized the importance of generative AI and LLM technologies in the company's future product roadmap and its plan to ensure that resources are focused on investing in these technologies and related product offerings. The company believes its position in the industry, long-standing customer relationships, and initial success with its recently announced generative AI products provide a solid foundation to reinvigorate growth in the future.

Conclusion

Cerence Inc. is navigating a challenging period in the automotive industry, marked by production delays, macroeconomic headwinds, and a slower-than-anticipated ramp-up in adjacent markets. However, the company's focus on cost optimization, investment in generative AI and LLM technologies, and its strong customer relationships position it well to weather the current storm and capitalize on future growth opportunities.

While the company's financial performance has been impacted by these industry-wide challenges, Cerence's commitment to innovation and its ability to deliver customized, branded virtual assistants to automakers remain key strengths. As the company continues to execute on its strategic priorities, investors will be closely watching its ability to convert the deals in its pipeline, release successful generative AI solutions, and drive profitability and cash flow improvements.

Overall, Cerence's long-term potential remains promising, as the company leverages its technological expertise and deep industry relationships to navigate the evolving automotive landscape and deliver value to its customers and shareholders.