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May 10, 2022, 3:10 p.m. EDT

10-Q: CERENCE INC.

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(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our Unaudited Condensed Consolidated Financial Statements, and the related notes thereto, appearing elsewhere in this Quarterly Report on Form 10-Q ("Quarterly Report"), and our consolidated and combined financial statements and the related notes and other financial information included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, filed with the Securities and Exchange Commission ("SEC") on November 23, 2021. Some of the information contained in this discussion and analysis or elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business, our performance and future success, our liquidity and capital resources, the impact of the COVID-19 pandemic on our business, results of operations and financial condition, macroeconomic conditions, the semiconductor shortage, and trends in the global auto industry, includes forward-looking statements that involve risks and uncertainties. See "Cautionary Statement Concerning Forward-Looking Statements." You should review the "Risk Factors" section in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, as updated by Part II, Item 1A of this Quarterly Report, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Note that the results of operations for the three and six months ended March 31, 2022 are not necessarily indicative of what our operating results for the full fiscal year will be. In this Item, "we," "us," "our," "Cerence" and the "Company" refer to Cerence Inc. and its consolidated subsidiaries, collectively.

Overview

Cerence builds AI powered virtual assistants for the mobility/transportation market. Our primary target is the automobile market, but our solutions can apply to all forms of transportation, including, but not limited to, two-wheel vehicles, planes, tractors, cruise ships and elevators. Our solutions power natural conversational and intuitive interactions between automobiles, drivers and passengers, and the broader digital world. We possess one of the world's most popular software platforms for building automotive virtual assistants. Our customers include all major original equipment manufacturers ("OEMs") or their tier 1 suppliers worldwide. We deliver our solutions on a white-label basis, enabling our customers to deliver customized virtual assistants with unique, branded personalities and ultimately strengthening the bond between automobile brands and end users. Our vision is to enable a more enjoyable, safer journey for everyone.

Our principal offering is our software platform, which our customers use to build virtual assistants that can communicate, find information and take action across an expanding variety of categories. Our software platform has a hybrid architecture combining edge software components with cloud-connected components. Edge software components are installed on a vehicle's head unit and can operate without access to external networks and information. Cloud-connected components are comprised of certain speech and natural language understanding related technologies, AI-enabled personalization and context-based response frameworks, and content integration platform.

We generate revenue primarily by selling software licenses and cloud-connected services. Our edge software components are typically sold under a traditional per unit perpetual software license model, in which a per unit fee is charged on a variable basis for each software instance installed on an automotive head unit. We typically license cloud-connected software components in the form of a service to the vehicle end user, which is paid for in advance. In addition, we generate professional services revenue from our work with our customers during the design, development and deployment phases of the vehicle model lifecycle and through maintenance and enhancement projects. We have existing relationships with all major OEMs or their tier 1 suppliers, and while our customer contracts vary, they generally represent multi-year engagements, giving us some level of visibility into future revenue.

Impact of COVID-19 on our Business

The COVID-19 pandemic has resulted in, and may continue to result in, additional governmental restrictions and regulations, which has adversely affected, and may continue to adversely affect our business and financial results. For example, pandemic related lockdowns were experienced in China throughout March 2022, which resulted in loss of automotive production. We have seen, and anticipate that we will continue to see, supply chain challenges in the automotive industry related to semiconductor devices that are used in automobiles. The current macroeconomic conditions have also increased competition for qualified employees in our industry, particularly for members of our professional service teams, and we, along with automotive OEMs, face significant competition in hiring and retaining them. In addition, a recession, depression or other sustained adverse market impact resulting from COVID-19 could materially and adversely affect our business, our access to needed capital and liquidity, and the value of our common stock. Even after the COVID-19 pandemic has lessened or subsided, we may continue to experience adverse impacts on our business and financial performance as a result of its global economic impact.

As the full impact of the COVID-19 pandemic on our business continues to develop, we are closely monitoring the global situation. We are unable at this time to predict the full impact of COVID-19 on our operations, liquidity, and financial results, and, depending on the magnitude and duration of the COVID-19 pandemic, such impact may be material. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. While we are unable to accurately predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures, these measures have impacted, and may continue to impact, our business, as well as our customers and consumers. For further discussion of the business risks associated with COVID-19, see Item 1A, Risk Factors, within our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, as updated by Part II, Item 1A of this Quarterly Report.

Basis of Presentation

The financial information presented in the accompanying unaudited condensed consolidated financial statements has been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") and in accordance with rules and regulations of the SEC regarding interim financial reporting. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The condensed consolidated balance sheet data as of September 30, 2021 was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting primarily of normal recurring accruals, necessary for a fair presentation of our financial position and results of operations. The operating results for the three and six months ended March 31, 2022 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2022.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company, as well as those of its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.

Key Metrics

In evaluating our financial condition and operating performance, we focus on revenue, operating margins, and cash flow from operations.

For the three months ended March 31, 2022 as compared to the three months ended March 31, 2021:

Operating margin decreased 10.3 percentage points to 7.3% from 17.6%.

Cash provided by operating activities was $1.6 million, a decrease of $14.6 million from cash provided by operating activities of $16.2 million.

For the six months ended March 31, 2022 as compared to the six months ended March 31, 2021:

Operating margin decreased 1.9 percentage points to 16.2% from 18.1%.

Cash provided by operating activities was $6.7 million, a decrease of $20.3 million from cash provided by operating activities of $27.0 million.







        Operating Results
        The following table shows the Condensed Consolidated Statement of Operations for
        the three and six months ended March 31, 2022 and 2021 (dollars in thousands):
                                                       Three Months Ended March 31,           Six Months Ended March 31,
                                                         2022                 2021               2022               2021
        Revenue:
        License                                     $       46,308       $       54,371     $       93,158       $  100,785
        Connected services                                  19,326               27,736             47,485           53,666
        Professional services                               20,646               16,555             40,063           37,854
        Total revenues                                      86,280               98,662            180,706          192,305
        Cost of revenue:
        License                                                386                1,181              1,107            1,855
        Connected services                                   5,651                6,839             11,375           13,852
        Professional services                               17,372               16,325             33,275           33,647
        Amortization of intangible assets                      897                1,879              2,776            3,758
        Total cost of revenues                              24,306               26,224             48,533           53,112
        Gross profit                                        61,974               72,438            132,173          139,193
        Operating expenses:
        Research and development                            29,976               28,864             55,768           52,995
        Sales and marketing                                  8,309                9,555             14,188           18,563
        General and administrative                          13,800               12,956             21,327           25,390
        Amortization of intangible assets                    3,135                3,183              6,289            6,341
        Restructuring and other costs, net                     474                  537              5,389            1,017
        Total operating expenses                            55,694               55,095            102,961          104,306
        Income from operations                               6,280               17,343             29,212           34,887
        Interest income                                         83                   16                173               34
        Interest expense                                    (3,360 )             (3,476 )           (6,787 )         (7,275 )
        Other income (expense), net                            (34 )              3,496               (286 )          1,259
        Income before income taxes                           2,969               17,379             22,312           28,905
        Provision for (benefit from) income taxes            3,445                6,216              3,744           (3,199 )
        Net (loss) income                           $         (476 )     $       11,163     $       18,568       $   32,104
        


Our revenue consists primarily of license revenue, connected services revenue and revenue from professional services. License revenue primarily consists of license royalties associated with our edge software components. Our edge software components are typically sold under a traditional per unit perpetual software license model, in which a per unit fee is charged for each software instance installed on an automotive head unit. Our contracts contain variable, fixed prepaid or fixed minimum purchase commitment components. Revenue is recognized and cash is collected for variable contracts over the license distribution period. The fixed contracts typically provide the customer with a price discount and can include the conversion of a variable contract that is already in our variable backlog. Revenue for fixed contracts is recognized when the software is made available to the customer, which has typically occurred at the time the contract is signed. Cash is typically expected to be collected for a fixed prepaid deal at the inception of the contract. Cash is expected to be collected for a fixed minimum commitment deal over the license distribution period. See Note 3 to the accompanying unaudited condensed consolidated financial statements for further discussion of our revenue, deferred revenue performance obligations and the timing of revenue recognition. Costs of license revenue primarily consists of third-party royalty expenses for certain external technologies we leverage.

Connected services revenue primarily represents the subscription fee that provides access to our connected services components, including the customization and construction of our connected services solutions. We also derive revenue within our connected services business from usage contracts and there can be instances where a customer purchases a software license that allows them to take possession of the software to enable hosting by the customer or a third-party. Subscription and usage contracts typically have a term of one to five years. Subscription revenue is recognized over the subscription period and cash is expected to be collected at the start of the subscription period. Usage based revenue is recognized and cash is collected as the service is used. If the customer takes possession of the software to have it hosted by the customer or a third-party, revenue is recognized, and cash is collected at the time the license is delivered. See Note 3 to the accompanying unaudited condensed consolidated financial statements for further discussion of our revenue, deferred revenue performance obligations and the timing of revenue recognition. Cost of connected service revenue primarily consists of labor costs of software delivery services, infrastructure, and communications fees that support our connected services solutions.

Professional services revenue is primarily comprised of porting, integrating, and customizing our embedded solutions, with costs primarily consisting of compensation for services personnel, contractors and overhead.

Our operating expenses include R&D, sales and marketing and general and administrative expenses. R&D expenses primarily consist of salaries, benefits, and overhead relating to research and engineering staff. Sales and marketing expenses includes salaries, benefits, and commissions related to our sales, product marketing, product management, and business unit management teams. General and administrative expenses primarily consist of personnel costs for administration, finance, human resources, general management, fees for external professional advisers including accountants and attorneys, and provisions for credit losses.

Amortization of acquired patents and core technology are included within cost of revenues whereas the amortization of other intangible assets, such as acquired customer relationships, trade names and trademarks, are included within operating expenses. Customer relationships are amortized over their estimated economic lives based on the pattern of economic benefits expected to be generated from the use of the asset. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives.

Restructuring and other costs, net include restructuring expenses as well as other charges that are unusual in nature, are the result of unplanned events, and arise outside the ordinary course of our business.

Total other expense, net consists primarily of foreign exchange gains (losses), losses on the extinguishment of debt and interest expense related to the Notes, the Senior Credit Facilities, and the Credit Agreement, dated October 1, 2019, by and among the Company, the lenders and issuing banks party thereto and Barclays Bank PLC, as administrative agent, which we repaid using proceeds from the issuance of the Notes.

Three Months Ended March 31, 2022 Compared with Three Months Ended March 31, 2021







        Total Revenues
        The following table shows total revenues by product type, including the
        corresponding percentage change, for the three months ended March 31, 2022 and
        2021 (dollars in thousands):
                                                          Three Months Ended March 31,                        % Change
                                              2022           % of Total        2021        % of Total       2022 vs. 2021
        License                            $   46,308          53.7%         $ 54,371        55.1%                   (14.8 )%
        Connected services                     19,326          22.4%           27,736        28.1%                   (30.3 )%
        Professional services                  20,646          23.9%           16,555        16.8%                    24.7 %
        Total revenues                     $   86,280                        $ 98,662                                (12.5 )%
        


Total revenues for the three months ended March 31, 2022 were $86.3 million, an decrease of $12.4 million, or 12.5%, from $98.7 million for the three months ended March 31, 2021. The decrease in revenues was driven by decreases in licensing revenues and decreased demand for our connected services. Our license revenue is highly dependent on vehicle production. Over the course of the past year, third-party light vehicle production forecasts for calendar year 2022 have decreased in response to the ongoing semiconductor shortage, conflict between Russia and Ukraine, and the growing effects of lockdowns in mainland China driven by COVID-19. While we cannot predict the full impact we will have from the forecasted decline in production, we do expect to be negatively impacted for the remainder of the fiscal year.

License Revenue

License revenue for the three months ended March 31, 2022 was $46.3 million, a decrease of $8.1 million, or 14.8%, from $54.4 million for the three months ended March 31, 2021. Variable license revenue decreased by $16.9 million primarily due to a lower volume of licensing royalties. This decrease, which was due in part to consumption of fixed license contracts, was partially offset by an $8.4 million increase in minimum purchase commitment and prepaid deals with customers. During the three months ended March 31, 2022, an existing variable long-term contract with our largest customer was converted into a minimum purchase commitment deal that accounted for $19.9 million of revenue in the current quarter. The cash associated with this deal is expected to be collected over the distribution period, which could be up to five years. The estimated future revenue related to this long-term contract was previously included in our variable backlog. As a percentage of total revenues, license revenue decreased 1.4 percentage points from 55.1% for the three months ended March 31, 2021 to 53.7% for the three months ended March 31, 2022.

Connected Services Revenue

Connected services revenue for the three months ended March 31, 2022 was $19.3 million, a decrease of $8.4 million, or 30.3%, from $27.7 million for the three months ended March 31, 2021. This decrease was primarily driven by the winding down of a legacy contract acquired by Nuance Communications, Inc. ("Nuance") through a 2013 acquisition. As a percentage of total revenues, connected services revenue decreased by 5.7 percentage point from 28.1% for the three months ended March 31, 2021 to 22.4% for the three months ended March 31, 2022.

Professional Services Revenue

Professional service revenue for the three months ended March 31, 2022 was $20.6 million, an increase of $4.0 million, or 24.7%, from $16.6 million for the three months ended March 31, 2021. This increase was primarily driven by our continued focus on integration and customization services related to our edge software and timing of services rendered. As a percentage of total revenues, professional services revenue increased by 7.1 percentage points from 16.8% for the three months ended March 31, 2021 to 23.9% for the three months ended March 31, 2022.







        Six Months Ended March 31, 2022 Compared with Six Months Ended March 31, 2021
        Total Revenues
        The following table shows total revenues by product type, including the
        corresponding percentage change, for the six months ended March 31, 2022 and
        2021 (dollars in thousands):
                                                          Six Months Ended March 31,                        % Change
                                             2022         % of Total        2021         % of Total       2022 vs. 2021
        License                            $  93,158        51.6%         $ 100,785        52.4%                    (7.6 )%
        Connected services                    47,485        26.3%            53,666        27.9%                   (11.5 )%
        Professional services                 40,063        22.1%            37,854        19.7%                     5.8 %
        Total revenues                     $ 180,706                      $ 192,305                                 (6.0 )%
        


Total revenues for the six months ended March 31, 2022 were $180.7 million, an decrease of $11.6 million, or 6.0%, from $192.3 million for the six months ended March 31, 2021. The decrease in revenues was driven by decreases in licensing revenues and decreased demand for our connected services. Our license revenue is highly dependent on vehicle production. Over the course of the past year, third-party light vehicle production forecasts for calendar year 2022 have decreased in response to the ongoing semiconductor shortage, conflict between Russia and Ukraine, and the growing effects of lockdowns in mainland China driven by COVID-19. While we cannot predict the full impact we will have from the forecasted decline in production, we do expect to be negatively impacted for the remainder of the fiscal year.

License Revenue

License revenue for the six months ended March 31, 2022 was $93.2 million, a decrease of $7.6 million, or 7.6%, from $100.8 million for the six months ended March 31, 2021. Variable license revenue decreased by $31.7 million primarily due to a lower volume of licensing royalties. This decrease, which was due in part to consumption of fixed license contracts, was partially offset by an $18.4 million increase in minimum purchase commitment and prepaid deals and $5.2 million from a one-time volume commitment deal with a fitness customer. During the six months ended March 31, 2022, certain existing variable long-term contracts with our largest customer were converted into minimum purchase commitment deals that accounted for $40.1 million of revenue during such six-month period. The cash associated with these deals is expected to be collected over the distribution period, which could be up to five years. The estimated future revenue related to these long-term contracts was previously included in our variable backlog. As a percentage of total revenues, license revenue decreased by 0.8 percentage points from 52.4% for the six months ended March 31, 2021 to 51.6% for the six months ended March 31, 2022.

Connected Services Revenue

Connected services revenue for the six months ended March 31, 2022 was $47.5 million, a decrease of $6.2 million, or 11.5% from $53.7 million for the six months ended March 31, 2021. This decrease was primarily driven by the winding down of a legacy contract acquired by Nuance through a 2013 acquisition. As a percentage of total revenues, connected services revenue decreased by 1.6 percentage points from 27.9% for the six months ended March 31, 2021 to 26.3% for the six months ended March 31, 2022.

Professional Services Revenue

Professional service revenue for the six months ended March 31, 2022 was $40.1 million, an increase of $2.2 million, or 5.8%, from $37.9 million for the six months ended March 31, 2021. This increase was primarily driven by our continued focus on integration and customization services related to our edge software and timing of services rendered. As a percentage of total revenues, professional services revenue increased by 2.4 percentage points from 19.7% for the six months ended March 31, 2021 to 22.1% for the six months ended March 31, 2022.

Three Months Ended March 31, 2022 Compared with Three Months Ended March 31, 2021







        Total Cost of Revenues and Gross Profits
        The following table shows total cost of revenues by product type and the
        corresponding percentage change (dollars in thousands):
                                         Three Months Ended March 31,            % Change
                                           2022                 2021           2022 vs. 2021
        License                       $          386       $        1,181               (67.3 )%
        Connected services                     5,651                6,839               (17.4 )%
        Professional services                 17,372               16,325                 6.4 %
        Amortization of intangibles              897                1,879               (52.3 )%
        Total cost of revenues        $       24,306       $       26,224                (7.3 )%
        


The following table shows total gross profit by product type and the corresponding percentage change (dollars in thousands):







                                         Three Months Ended March 31,            % Change
                                           2022                 2021           2022 vs. 2021
        License                       $       45,922       $       53,190               (13.7 )%
        Connected services                    13,675               20,897               (34.6 )%
        Professional services                  3,274                  230              1323.5 %
        Amortization of intangibles             (897 )             (1,879 )              52.3 %
        


Total gross profit $ 61,974 $ 72,438 (14.4)%

Total cost of revenues for the three months ended March 31, 2022 were $24.3 million, a decrease of $1.9 million, or 7.3%, from $26.2 million for the three months ended March 31, 2021.

We experienced a decrease in total gross profit of $10.4 million, or 14.4%, from $72.4 million for the three months ended March 31, 2021 to $62.0 million for the three months ended March 31, 2022. The decrease was primarily driven by a decline in license and connected services revenues.

Cost of License Revenue

Cost of license revenue for the three months ended March 31, 2022 and 2021 was $0.4 million, a decrease of $0.8 million, or 67.3%, from $1.2 million for the . . .

May 10, 2022

COMTEX_406988720/2041/2022-05-10T15:09:59

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