CRNC - Cerence Shifts To A Generative AI Platform Approach For The Car

2023-12-18 13:26:18 ET

Summary

• Cerence Inc. recently reported its FQ4 2023 financial results, beating on revenue but missing consensus earnings estimates.
• The firm provides AI assistant technologies for in-automobile environments.
• Cerence Inc. is in transition to a new generative AI platform approach, which may impact its financial results in the near term.
• I remain Neutral [Hold] on Cerence Inc. stock for now.

A Quick Take On Cerence

Cerence Inc. ( CRNC ) reported its fiscal Q4 2023 financial results on November 27, 2023, beating revenue but missing consensus earnings estimates.

The firm provides AI assistant technologies for in-automobile environments.

I previously wrote about Cerence in April 2023 with a Hold outlook on supply chain challenges and shortages.

While Cerence Inc. supply chain problems have been reduced, given a higher expense outlook and downward revenue pressures, and with the company in transition to a new platform, its financial results may suffer in the near term.

According, I remain Neutral [Hold] on CRNC for now.

Cerence Overview And Market

Massachusetts-based Cerence began as a public company after a spin-out from parent firm Nuance Communications in 2019. It aims to further develop AI technologies to automate and enhance communications solutions for mobility environments worldwide.

The firm is led by CEO Stefan Ortmanns, who previously joined former parent firm Nuance in 2003 and has extensive career experience in the speech processing industry.

The company’s primary offerings include the following:

• Cerence Co-Pilot

• Cerence Drive

• Cerence Ride

• Cloud Services.

Cerence acquires new OEM clients via its direct business development efforts.

According to a 2023 market research report by Grand View Research, the global market for automotive AI software was estimated at $2.99 billion in 2022 and is forecast to reach $15.4 billion by 2030.

Cerence's software is for inside-the-car activity, but the report is relevant due to showing industry-wide growth prospects.

The growth estimate represents a forecast CAGR of 22.7% from 2023 to 2030, a very high growth potential, if achieved.

The primary reasons for this expected growth are demand from mobility companies to improve their technology offerings, do a better job of managing vehicle activity and further develop autonomous vehicles from rising demand by consumers.

Also, the chart below shows the Asia Pacific automotive AI market recent history and projected future growth forecast:

Major competitive or other industry participants include:

• Alphabet

• Intel

• Microsoft

• NVIDIA

• International Business Machines

• Qualcomm Inc.

• Tesla

• Volvo Car Corporation

• Bayerische Motoren Werke AG

• Audi AG.

Cerence’s Recent Financial Trends

Total revenue by quarter (blue columns) has been highly variable due to lumpy customer wins and a drop in professional services revenue; Operating income by quarter (red line) has turned positive in the most recent quarter because of rising gross profit and falling SG&A expenses:

Gross profit margin by quarter (green line) has risen as a result of higher-margin mix; Selling and G&A expenses as a percentage of total revenue by quarter (amber line) have dropped.

Earnings per share (Diluted) have remained materially negative:

(All data in the above charts is GAAP.)

In the past 12 months, CRNC’s stock price has fallen 3.42% vs. that of the iShares Expanded Technology-Software ETF’s ( IGV ) rise of 54.5%:

For balance sheet results, the firm ended the quarter with $110.4 million in cash, equivalents and short-term investments and $276.0 million in total debt, all of which was categorized as long-term.

Over the trailing twelve months, free cash flow was only $2.4 million, during which capital expenditures were $5.1 million. The company paid a hefty $40.8 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Cerence

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Based on the DCF, using a discount rate of 10% (10-year Treasury (US10Y) at 4% plus 6% equity risk premium) and forward earnings per share assumption of $1.43, the firm’s shares would be valued at approximately $15.21 versus the current price of $17.50, indicating they are potentially currently overvalued.

CNRC’s most recent unadjusted Rule of 40 calculation was negative (4.4%) as of FQ4 2023’s results, so the firm has improved but continues to perform poorly in this regard, per the table below:

(Source - Seeking Alpha.)

Commentary On Cerence

In its most recent earnings call (Source - Seeking Alpha ), management’s prepared remarks highlighted seeing strong interest among OEM customers for its generative AI development in its automotive offering road map.

Management is now more focused on creating its complete AI solution, which it calls the Cerence Assistant platform with proactive AI, instead of developing products for software adjacencies in the car.

The firm has 15 proof-of-concept programs underway and expects to go live in Q1 2024 with its first solution.

Notably, the company expects to "continue to invest heavily in R&D" to effect its strategy change into LLM AI platform technology offerings.

Analysts questioned the leadership about financial guidance, proof of concept programs and connected services/Toyota. Management responded that prepaid fixed contracts are being reduced from $40 million to $20 million

Leadership did not comment on when it will start seeing bookings from the proof of concept programs other than to reiterate that it expects to see "bookings over the next couple of months here for sure."

The firm is producing growth in its connected services revenue and management believes it is "going to be a big growth driver going forward."

For the quarter’s results, total revenue rose 39.1% YoY and gross profit margin increased by 13.2%.

Selling and G&A expenses as a percentage of revenue fell by 11.8% year-over-year, so operating income exceeded breakeven.

The company's financial position is solid, with ample liquidity, long-term only debt and slight positive free cash flow.

CNRC’s Rule of 40 performance has improved slightly, but remains negative, a poor performance.

Looking ahead, 2024 full fiscal year revenue is expected to be $365 million at the midpoint of the range, or 11.3% over fiscal 2023’s results

A potential upside catalyst to the stock could include a marquee customer announced in Q1 2024 for its new generative AI platform approach.

However, management says they expect a revenue trough as they shift their focus to the AI platform approach.

Also, R&D will likely continue to be a substantial and growing expense, as the chart below shows its material upward trend in recent quarters:

Given a higher expense outlook and downward revenue pressures, with the company in transition to a new platform, its financial results may suffer in the near term.

According, I’m Neutral [Hold] on Cerence Inc. shares for now.

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