Cerence Inc. (Nasdaq: CRNC) — Q3 FY2022 Form 10-Q
Business context and period. Cerence provides AI-powered voice assistants and related software, connected services, and professional services primarily to automotive manufacturers and suppliers. This unaudited report covers the three and nine months ended June 30, 2022; comparisons are with the corresponding 2021 periods.
Financial performance
| Metric | Three months ended June 30, 2022 | Year-over-year change | Nine months ended June 30, 2022 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $89.0m | Down 8.0% | $269.7m | Down 6.7% |
| Gross profit / margin | $64.8m / 72.8% | Profit down 11.2%; margin was about 75.4% in 2021 | $197.0m / 73.0% | Profit down 7.2%; margin was about 73.4% in 2021 |
| Operating income / margin | $15.8m / 17.7% | Income up from $14.9m; margin up from 15.4% | $45.0m / 16.7% | Income down from $49.8m; margin down from 17.2% |
| Net income (loss) | $(99.3)m | Compared with $5.8m income | $(80.7)m | Compared with $37.9m income |
| Operating cash flow | Management reports $3.9m cash used | Compared with $24.1m provided | $2.8m provided | Down from $51.1m provided |
Revenue mix. Quarterly license revenue was $46.5m (down 7.1%), connected-services revenue $20.0m (down 34.0%), and professional-services revenue $22.6m (up 36.6%). For the nine-month period, those categories were $139.6m (down 7.4%), $67.5m (down 19.6%), and $62.7m (up 15.2%), respectively.
Cash, liquidity, and debt at June 30, 2022. Cash and cash equivalents were $108.5m; marketable securities totaled $27.7m, for $136.1m in combined cash, cash equivalents, and securities. Net working capital excluding deferred revenue and deferred costs was $168.5m. Total debt carrying value was $270.6m, including $175.0m principal of 3.00% convertible notes due 2025 and senior credit facility borrowings; no revolving-facility borrowings were outstanding. The company reported compliance with debt covenants, including a $75m minimum-liquidity requirement. Nine-month capital expenditures were $14.4m. Cash and cash equivalents declined $20.0m during the nine months.
Material changes and unusual items
- Tax charge drove the reported loss. The company recorded a $107.6m valuation allowance against Netherlands deferred tax assets, following changes to transfer-pricing arrangements and fiscal 2022 earnings expectations. The nine-month tax provision was $114.7m, versus $2.9m in 2021; the quarterly provision was $111.0m. The allowance sharply reduced deferred tax assets.
- Revenue and cash-flow pressure. Lower license royalties reflected weaker vehicle production, including semiconductor constraints, China COVID-related lockdowns, and the Russia-Ukraine conflict. Connected-services revenue fell mainly as a legacy contract wound down. Management also cited unfavorable working-capital movements and lower deferred revenue in the nine-month operating cash-flow decline.
- Customer contract conversion. Certain variable contracts with the largest customer were converted to minimum-purchase commitments, accounting for $47.1m of nine-month revenue. Related cash is expected to be collected over the distribution period, potentially up to five years. Two customers represented 20.1% and 14.2% of nine-month revenue.
- Leadership-related compensation and restructuring. Nine-month restructuring and other costs were $6.6m, including $4.0m of stock-based compensation associated with the former CEO’s resignation and award modifications, plus severance and facility costs. The filing also reports award modifications associated with the former CFO’s retirement and former General Counsel’s resignation.
- Impairment assessments. No goodwill impairment was recorded, but estimated reporting-unit fair value of about $995m exceeded its $950m carrying value by only about 5%. The company also found no impairment of its long-lived asset group.
- Legal matters. A shareholder securities class action and consolidated shareholder derivative litigation were pending. The company said it could not estimate a reasonably possible loss range; it reported no material accrued litigation losses.
Outlook, risks, and management commentary
Management expected lower contributions from fixed license contracts in Q4 FY2022 and FY2023 after deciding to limit these contracts going forward, with a negative effect on reported license revenue. It also expected operating results to be negatively affected by lower vehicle-production forecasts for the remainder of FY2022. The filing provides no clear numerical earnings or revenue guidance. Management believed available liquidity and expected cash sources would meet needs over the next 12 months, while noting that prolonged economic disruption could affect operations, liquidity, and covenant compliance.
Key risks include automotive production and semiconductor supply, COVID-19 disruptions, inflation and higher interest rates, foreign-exchange exposure, customer concentration, contract renewals and cancellations, competition for skilled staff, and execution of the CEO transition. Goodwill valuation is particularly sensitive to forecasts and discount-rate assumptions. The company reported effective disclosure controls as of June 30, 2022.
Important facts for investors to verify
- Whether the Netherlands valuation allowance remains necessary, and its effect on future tax expense and deferred tax assets.
- Actual vehicle-production trends, license royalties, and the pace of the legacy connected-services contract wind-down.
- Collection timing and cash conversion of the $47.1m minimum-purchase commitment revenue, alongside the concentration of revenue and receivables among major customers.
- Operating cash flow, working-capital trends, and the company’s headroom against debt covenants and the minimum-liquidity test.
- Future license-revenue effects from limiting fixed contracts, and whether goodwill valuation headroom narrows further.
- Developments and potential financial exposure in the securities class action and derivative litigation.