Cerence Inc.

The Serence Third Quarter, Fiscal Year 2020 Conference Call Before we begin, I would like to remind you that this call may involve certain forward-looking statements These statements are subject to risks and uncertainties as described in the press release preceding today's call Serence makes no representations to update those statements after the date he robbed In addition, the company may refer to certain non-GAAP measures 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. Joining us today are Sanjay Dhawan, CERENT CEO, Mark Gallenberger, Serence CFO and Rich Yerganian, Serence VP of Investor Relations. As a reminder, the only authorized spokespeople for the company are Sanjay, Mark and Rich. I am here for the opening remarks and as a showcase for the new Serence Neural Text-to-Speech Innovations which have been called breathtaking by one of our most important customers. Before handing the call over, I'd like to announce several upcoming investor events. All of them have been converted to virtual events, so the exact timing of our participation is subject to change. Please visit the events page in the investor section of the CERNS website for the most up-to-date information on our participation. The conferences include the Raymond James Industrial Conference, the Jefferies Software Conference 2020, the RBC Capital Markets Global Industrial Conference, and the Evercore Future of Mobility Forum. Now on to the call. Sanjay.

Welcome to everyone on the call, and thank you for joining us to discuss Q3 results. Despite the challenging conditions, Serence continues to execute across the board. Before getting into the results, though, I want to acknowledge what you just heard, a demonstration of one of our newest products, Serence Reader. A neural text-to-speech application capable of reading articles based on linguistic styles associated with different types of content. Silence Reader takes advantage of the latest capabilities in AI and processing hardware to bring amazing levels of human-like speech to the car. It features long-form reading capabilities, including the automatic prediction of the appropriate reading style and emotional tone based on content, context, and category of news. Jean Dussek, head of development speech output at Audirect, commented that, sentence reader is quite breathtaking and will empower the next generation of our cars to interact with our customers on a whole new level. Salinas is just the latest example of Salinas engineers using AI to push the boundaries of what is capable in the car. As we're pushing the boundaries of what's possible, we're doing that for many of our customers, including Audi's MMI infotainment system and Ford SYNC 4 communication and entertainment system. But nowhere is this more demonstrated than in the 2021 S-Class Mercedes. In a call with the media promoting MBUX, Mercedes' cutting-edge infotainment system, Nils Schanz, head of user interaction, voice control at Daimler, commented, I think voice AI is the future in technology and automotive. At Serence, we would agree. On this same call, Nils offered some interesting statistics. He said 80% of Mercedes users say voice is the most important control element in the car. 83% of the consumers believe voice commands make it easier to search for information. And 89% said voice commands make searches faster. We're very proud of the role we have played in creating the MBUX experience. Continuing our string of new product introductions is Sales Pay. Using advanced voice biometrics, Sedans Pay allows the driver to make purchases from the car using his or her voice to authenticate payment. Whether it be to authorize payment for gasoline at the pump, parking your car, or ordering food or drink on the go, Sedans Pay provides a secure, contactless payment system. As the world continues to adjust to the realities of COVID-19, contactless payment Thank you. Thank you. that through their dedicated efforts, the company's business showed resilience and continued strong execution. We have stated that our combined revenues should allow us to deliver results 10 to 15% better than the autos are. Estimates are that global light vehicle sales were down as much as 45% in calendar Q2 compared to the same period a year ago. In our case, sales declined less than 4%. Though our first three-quarter sales are up 8% compared to fiscal year 19 for the same period, the secular trend driving our business continues to play out as the penetration of voice assistant technology and connected services extend to more and more car makes and models. This has been an important driver of our growth and we expect this trend to continue. In the long term, COVID-19 may actually have a positive impact on car sales once we get beyond the near-term economic headwinds as car ownership may increase as people decide to move from living in the city to suburbs or decide to purchase vehicles in lieu of public transportation. We commented on our last earnings call that while approximately half our business is tied directly to the quarterly production of new cars, the other half is not directly tied to current auto production. Our connected services, which is a SaaS revenue stream, was key in supporting sales for the quarter because the vast majority of connected services revenues are from cars that have already shipped. There was minimal impact on sales in the quarter. Our professional services business is also not tied to car production and delivered another strong quarter. The changes we made to our business very early in the pandemic have resulted in continued strong financial performance. Mark will fill you in on the details of the quarterly results in a few minutes, but we were able to still deliver non-GAAP net income of 12 million or 31 cents per share and generated approximately 24 million of adjusted EBITDA. Even in this difficult environment, our business held up very well. You may have noticed a new table in the press release providing a series of KPIs. After much internal discussion, it was decided that these KPIs would be helpful to investors in seeing the progression of our business. As you can see from the table, our technology is consistently shipped in more than half the cars produced globally. This translates into very strong market share position, especially for our edge technology. Next quarter, we'll add some KPIs on the adoption of connected services in the car. One of the more important metrics in the table are growth in billing per car shift showed strong growth compared to the prior year. The impact of COVID-19 aside, as a group, these statistics create a healthy picture of long-term growth prospects for tenants. You may recall that in our Q2 earnings release, we reported very strong bookings for the first half of the fiscal year. The pipeline of business opportunities continued in Q3, delivering the second highest quarter for bookings in the company's history. These bookings include several strategic wins for the company in each of our key geographic markets. We also had our first bookings in two adjacent markets, one for two-wheel vehicles and the other for tractors. As previously mentioned, we will provide a mid-year bookings update and year-end backlog update. This momentum is due to the steady pace of new technology that we are bringing to market. It is that innovation and our ability to deliver that continues to fuel the strong support we have from our customers on a global basis and why we have such a strong market position. In Q4, we hope to receive the first bookings for new products that enable us to achieve our 75 million SAS ARR revenue target in our 2024 model. The recently announced tenants pay and our previously announced car life are expected to be significant contributors to the 75 million revenue target. Another product we have yet to officially announce has been well received by customers, but we are not quite ready to officially launch that product yet. More news on that and others in the future. We're also looking at opportunities for aftermarket products to make available the latest in voice assistant technology for those cars already on the road without such capability. Our pipelines of new products extend well beyond the ones I mentioned earlier in my comments as we look to continuously advance the user experience inside the car. We do this by taking advantage of being embedded in the car's infotainment system, allowing us access to all of the sensors, cameras, and microphones throughout the car and leveraging that access to provide the driver the safest and most Apple-like user experience possible. Innovation is what allows us to continue our market leadership position and provide the opportunity to expand into adjacent markets. In a world where voice Thank you very much. We're hopeful this trend continues. Although most of our customers are not providing guidance, we have enough confidence in our business to provide a Q4 outlook. Mark will provide more details in his comments. I'd like to now turn the call over to Mark to review the financial results of the quarter. Mark.

Thank you, Sanjay. I'll first provide an update on the impact of COVID-19 on our business, and then I'll review our performance for the third quarter of fiscal year 2020, and provide a recap of our successful refinancing during the quarter. Lastly, I'll review our guidance for Q4 before taking questions. While our China R&D facilities are essentially in full operation, the rest of our locations remain mostly remote and we do not expect a return to normal workplace operations until the fall timeframe at the earliest, but more likely once a vaccine is available. Those offices that have opened have done so by following local guidelines. Although the majority of our workforce is still remote, we continue to deliver on key project milestones, and our productivity has seen minimal impact as a result of these new work conditions. We realized approximately $6 million of cost savings in the quarter due to the cost reduction actions that were taken in response to the onset of COVID-19. And our expected $8 million of CapEx savings from our original plan is still on track. Next, this table provides a breakdown of the different revenue streams that make up our business. And you can see that our overall license revenue in the quarter was down 26% from the prior year. This is directly related to the impact of COVID-19 on auto production during the quarter. As Sanjay mentioned in his comments, the license revenue is the part of our business that is most directly related to quarterly auto shipments. Our cloud-connected SaaS revenue grew by 27% from the prior year, and professional services grew by 25%. As mentioned on prior calls, the growth in pro services is a leading indicator of future growth potential of our licensed and connected services as these projects move into start of production. At approximately $75 million, our revenue for the quarter was down less than 4% while global auto sales declined approximately 45% resulting in significant outperformance above auto unit sales during the period. Year-to-date revenue is up 8% compared to the same time period last year despite the impact of COVID-19. Licensed prepaid contracts were $14 million in the quarter, down from $16 million in Q2, but up from $11 million a year ago. Non-GAAP gross margin for the quarter was 68.7% and slightly lower than last quarter due to lower volume and product mix, and specifically driven by the drop in license revenue, which carries nearly 100% margin. Non-GAAP operating margin for the company was strong at 28.4%, and adjusted EPTA was $23.8 million, or 31.8% of revenue. Our non-GAAP net income was $12.1 million, or $0.31 per share, and our cash flow from operations was $19.3 million, which was a significant improvement over the previous quarter. Given the difficult business environment over the last several months, our Q3 results represent a great quarter of execution and financial performance. We successfully refinanced our debt by replacing a very expensive term loan B with a combination of a $175 million convertible note, a $125 million term loan A, and a $50 million revolving line of credit. The refinancing resulted in approximately 50% reduction of our cash interest expense, and this translates into over $10 million per year in cash interest savings, and has a substantial accretive effect on non-GAAP net income. We ended the quarter with approximately $133 million of cash, up approximately $37 million over the previous quarter. Approximately $23 million of the increase is attributed to the additional debt net of fees, while the balance of approximately $13 million is attributed to our strong free cash flow generated during the quarter. While the business environment remains volatile and with about three to four months of experience operating under these new conditions, we feel comfortable providing guidance for Q4. Therefore, our guidance for Q4 is for revenue to be up sequentially and to be in the range of $76 to $80 million, representing a 4% sequential growth at the midpoint. We expect non-gap gross margin between 68% and 70%. Non-GAAP operating margin between 27 and 29%, adjusted EBITDA between $23 million and $26 million, Non-GAAP EPS between 30 cents and 35 cents, and CFFO of approximately $24 million, putting our full fiscal year CFFO at approximately $43 million, which is within the original range of our guidance that we provided at the beginning of the year. We are also maintaining our fiscal year 2024 midterm target model, including revenue of $600 million that we provided at our analyst day in February. In summary, in spite of COVID-19's impact on our business, we delivered a great quarter. The performance reflects both the resilience and operating performance potential of the company. Thank you. Thank you. Thank you.