Cerence Inc. — Q2 FY2020 Form 10-Q
Reporting period: Quarter and six months ended March 31, 2020. Cerence provides AI-powered voice assistants and connected software and services for automakers. It was spun off from Nuance on October 1, 2019; fiscal 2019 comparative results are carve-out combined figures, so comparability is affected by the change from Nuance-owned business to a standalone public company.
Financial performance
Amounts below are in millions of dollars except per-share data. Quarterly and six-month comparisons are to the corresponding 2019 periods.
| Metric | Three months 2020 | Three months 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $86.5 | $70.3 | $164.0 | $142.8 |
| Gross profit / margin | $57.8 / 66.8% | $45.9 / 65.2% | $109.3 / 66.7% | $94.1 / 65.9% |
| Operating income / margin | $12.0 / 13.9% | $0.2 / 0.2% | $9.9 / 6.0% | $3.0 / 2.1% |
| Net income | $12.5 | $0.5 | $0.7 | $2.7 |
| Diluted EPS | $0.33 | $0.01 | $0.02 | $0.07 |
- Quarterly revenue mix: license $44.6 million (+13%); connected services $23.1 million (+23%); professional services $18.7 million (+55%). Growth was attributed mainly to connected and professional services demand and new license royalty deals.
- Six-month revenue mix: license $85.4 million (+2%); connected services $46.2 million (+28%); professional services $32.4 million (+39%). Connected services and professional services were the main growth drivers.
- Operating expenses: quarterly R&D was $21.3 million (down 5%) and sales and marketing $7.7 million (down 21%); G&A rose 88% to $10.7 million, primarily due to salaries, stock compensation, software fees and bad-debt allowances. Six-month G&A rose 95% to $22.2 million.
- Taxes and unusual items: the quarter included a $6.7 million income tax benefit; the six-month period included a $3.7 million benefit, including approximately $5.0 million from a Netherlands tax-rate change. Interest expense was $6.7 million for the quarter and $13.5 million for six months, reflecting the new debt. Restructuring and other costs were $2.9 million for the quarter and $10.4 million for six months, including standalone-company separation costs.
Cash, liquidity and debt
- At March 31, cash and cash equivalents were $95.6 million; current assets were $222.9 million and current liabilities $189.2 million. Deferred revenue totaled $348.1 million, including $113.1 million current.
- For the six months, operating cash flow was negative $0.7 million, investing cash flow negative $10.1 million, and financing cash flow positive $106.4 million. Financing included $249.7 million net proceeds from debt and a $153.0 million distribution to Nuance. Capital expenditures were $10.1 million.
- The MD&A cites $10.2 million of cash used in operating activities for the three-month period; the supplied cash flow statement reports only six-month cash flow, so a quarterly cash-flow figure cannot be independently verified from the presented statement.
- Debt carrying value was $247.4 million, comprising $9.5 million current and $237.9 million long term. The term loan’s principal before unamortized discount and issuance costs was approximately $267.6 million; the $75 million revolving facility was undrawn. Cash less debt carrying value implies approximately $151.8 million net debt.
- Debt bears floating-rate interest at adjusted LIBOR plus 6.00% or base rate plus 5.00%. The company reported compliance with covenants, including a maximum 6.00-to-1.00 net first-lien leverage ratio, and expected to remain compliant for the foreseeable future. A 1% rate increase, assuming the revolver fully drawn, was estimated to increase annual interest expense by about $3.43 million.
Outlook, risks and contingencies
- Cerence withdrew its previously issued FY2020 guidance because of uncertainty around COVID-19. Management expected a material second-half FY2020 impact on license and connected-services billings and revenue, earnings and cash flow, potentially extending beyond the fiscal year.
- Automotive plant shutdowns and lower production and shipments could weaken customer demand, delay programs and impair collections. Management shifted some R&D staff to customer services, cut discretionary spending and contractors, deferred hiring and reduced executive salaries temporarily. CEO salary was reduced 20% and other named executive officers’ salaries 10%, effective April 1; amounts may be paid later at the Compensation Committee’s discretion.
- On April 8, after quarter-end, Cerence committed to a cost-efficiency program that included terminating approximately 75 employees; it expected about $2.6 million of severance charges in the second half of FY2020.
- COVID-19 impairment indicators prompted interim tests. Goodwill fair value was estimated at about $951 million versus a $936 million carrying value, only about 2% headroom; no impairment was recorded. Long-lived assets were also found recoverable. Further deterioration in assumptions could result in impairment.
- Management believed available cash and expected operating cash flows would meet liquidity needs for the next 12 months, while noting that prolonged disruption could affect liquidity, covenant compliance and access to financing. Litigation accruals were not material, and management did not expect pending matters to have a material financial impact. No material off-balance-sheet arrangements were reported.
Most important facts for investors to verify
- How automotive production shutdowns affected subsequent license royalties, connected-service usage, customer project timing and receivables collections.
- Whether operating cash flow and liquidity improved after the reported six-month operating cash outflow, and how much of the revolving facility was available under its conditions.
- Debt repayment, floating-rate interest exposure and continued compliance with the leverage covenant as earnings and cash flows change.
- Goodwill valuation assumptions and the narrow $15 million estimated fair-value cushion, especially under continued COVID-19 disruption.
- The realization and timing of the withdrawn FY2020 outlook, cost reductions and expected restructuring charges, including the post-quarter workforce program.
- The effects of the spin-off on comparisons with prior carve-out results and the sustainability of growth and margins across revenue streams.