crnc-10q_20191231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2019

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number: 001-39030

 

CERENCE INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

83-4719946

( State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

15 Wayside Road

Burlington, Massachusetts

01803

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (857) 362-7300

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading

Symbol(s)

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share

 

CRNC

 

The Nasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes  ☒    No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐    No  

As of February 7, 2020, the registrant had 36,438,513 shares of common stock, $0.01 par value per share, outstanding.

 

 

 


Table of Contents

 

 

 

Page

PART I.

FINANCIAL INFORMATION

2

Item 1.

Consolidated and Combined Financial Statements (Unaudited)

2

 

Statements of Operations

2

 

Statements of Comprehensive Loss

3

 

Balance Sheets

4

 

Statements of Equity

5

 

Statements of Cash Flows

6

 

Notes to Consolidated and Combined Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

31

Item 4.

Controls and Procedures

31

PART II.

OTHER INFORMATION

32

Item 1.

Legal Proceedings

32

Item 1A.

Risk Factors

32

Item 6.

Exhibits

32

Signatures

33

 

 

i


CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, or Form 10-Q, filed by Cerence Inc. together with its consolidated subsidiaries, “Cerence” or the “Company,” “we,” “us” or “our” unless the context indicates otherwise, contains “forward-looking statements” that involve risks and uncertainties. These statements can be identified by the fact that they do not relate strictly to historical or current facts, but rather are based on current expectations, estimates, assumptions and projections about our industry and our business and financial results. Forward-looking statements often include words such as “anticipates,” “estimates,” “expects,” “projects,” “forecasts,” “intends,” “plans,” “continues,” “believes,” “may,” “will,” “goals” and words and terms of similar substance in connection with discussions of future operating or financial performance. As with any projection or forecast, forward-looking statements are inherently susceptible to uncertainty and changes in circumstances. Our actual results may vary materially from those expressed or implied in our forward-looking statements. Accordingly, undue reliance should not be placed on any forward-looking statement made by us or on our behalf. Although we believe that the forward-looking statements contained in this Form 10-Q are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those in such forward-looking statements, including but not limited to:

 

the highly competitive and rapidly changing market in which we operate;

 

adverse conditions in the automotive industry or the global economy more generally;

 

our strategy to increase cloud services and fluctuations in our operating results;

 

escalating pricing pressures from our customers;

 

our failure to win, renew or implement service contracts;

 

the cancellation or postponement of service contracts after a design win;

 

the loss of business from any of our largest customers;

 

transition difficulties with our first senior management team;

 

inability to recruit and retain qualified personnel;

 

cybersecurity and data privacy incidents that damage client relations;

 

economic, political, regulatory, foreign exchange and other risks of international operations;

 

unforeseen U.S. and foreign tax liabilities;

 

the failure to protect our intellectual property or allegations that we have infringed the intellectual property of others;

 

defects in our software products that result in lost revenue, expensive corrections or claims against us;

 

our inability to quickly respond to changes in technology and to develop our intellectual property into commercially viable products;

 

a significant interruption in the supply or maintenance of our third-party hardware, software, services or data; and

 

certain factors discussed elsewhere in this Form 10-Q.

These and other factors are more fully discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2019 and elsewhere in this Form 10-Q. These risks could cause actual results to differ materially from those implied by forward-looking statements in this Form 10-Q. Even if our results of operations, financial condition and liquidity and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Form 10-Q, those results or developments may not be indicative of results or developments in subsequent periods.

Any forward-looking statements made by us in this Form 10-Q speak only as of the date on which they are made. We are under no obligation to, and expressly disclaim any obligation to, update or alter our forward-looking statements, whether as a result of new information, subsequent events or otherwise, except as required by law.

1


PART I—FINANCIAL INFORMATION

Item 1. Consolidated and Combined Financial Statements.

CERENCE INC.

CONSOLIDATED STATEMENT OF OPERATIONS FOR THREE MONTHS ENDED DECEMBER 31, 2019

COMBINED STATEMENT OF OPERATIONS FOR THREE MONTHS ENDED DECEMBER 31, 2018

(Dollars in thousands, except share and per share data)

(unaudited)

 

 

 

Three Months Ended December 31,

 

 

 

2019

 

 

2018

 

Revenues:

 

 

 

 

 

 

 

 

License

 

$

40,767

 

 

$

44,002

 

Connected services

 

 

23,021

 

 

 

17,255

 

Professional services

 

 

13,671

 

 

 

11,227

 

Total revenues

 

 

77,459

 

 

 

72,484

 

Cost of revenues:

 

 

 

 

 

 

 

 

License

 

 

681

 

 

 

340

 

Connected services

 

 

8,675

 

 

 

11,229

 

Professional services

 

 

14,491

 

 

 

10,463

 

Amortization of intangible assets

 

 

2,087

 

 

 

2,175

 

Total cost of revenues

 

 

25,934

 

 

 

24,207

 

Gross profit

 

 

51,525

 

 

 

48,277

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

23,511

 

 

 

23,808

 

Sales and marketing

 

 

7,943

 

 

 

9,445

 

General and administrative

 

 

11,483

 

 

 

5,721

 

Amortization of intangible assets

 

 

3,131

 

 

 

3,132

 

Restructuring and other costs, net

 

 

7,554

 

 

 

3,127

 

Acquisition-related costs

 

 

 

 

 

235

 

Total operating expenses

 

 

53,622

 

 

 

45,468

 

(Loss) income from operations

 

 

(2,097

)

 

 

2,809

 

Interest income

 

 

281

 

 

 

 

Interest expense

 

 

(6,798

)

 

 

 

Other income (expense), net

 

 

(146

)

 

 

(16

)

(Loss) income before income taxes

 

 

(8,760

)

 

 

2,793

 

Provision for income taxes

 

 

3,002

 

 

 

538

 

Net (loss) income

 

$

(11,762

)

 

$

2,255

 

Net (loss) income per share:

 

 

 

 

 

 

 

 

Basic

 

$

(0.33

)

 

$

0.06

 

Diluted

 

$

(0.33

)

 

$

0.06

 

Weighted-average common share outstanding:

 

 

 

 

 

 

 

 

Basic

 

 

35,995,355

 

 

 

36,391,445

 

Diluted

 

 

35,995,355

 

 

 

36,391,445

 

 

Refer to accompanying Notes to the unaudited consolidated and combined financials statements.

2


CERENCE INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS FOR THREE MONTHS ENDED DECEMBER 31, 2019

COMBINED STATEMENT OF COMPREHENSIVE LOSS FOR THREE MONTHS ENDED DECEMBER 31, 2018

(Dollars in thousands)

(unaudited)

 

 

 

Three Months Ended December 31,

 

 

 

2019

 

 

2018

 

Net (loss) income

 

$

(11,762

)

 

$

2,255

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

4,904

 

 

 

(3,707

)

Pension adjustments

 

 

926

 

 

 

322

 

Total other comprehensive income (loss)

 

 

5,830

 

 

 

(3,385

)

Comprehensive loss

 

$

(5,932

)

 

$

(1,130

)

 

Refer to accompanying Notes to the unaudited consolidated and combined financials statements.

3


CERENCE INC.

CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2019 (UNAUDITED)

COMBINED BALANCE SHEET AS OF SEPTEMBER 30, 2019

(Dollars in thousands, except share data)

 

 

 

December 31,

2019

 

 

September 30,

2019

 

ASSETS

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

113,396

 

 

$

-

 

Accounts receivable, net of allowances of $881 and $865 at December 31, 2019 and September 30, 2019, respectively

 

 

64,928

 

 

 

65,787

 

Deferred costs

 

 

6,915

 

 

 

9,195

 

Prepaid expenses and other current assets

 

 

35,630

 

 

 

17,343

 

Total current assets

 

 

220,869

 

 

 

92,325

 

Property and equipment, net

 

 

24,070

 

 

 

20,113

 

Deferred costs

 

 

36,052

 

 

 

32,428

 

Operating lease right of use assets

 

 

19,681

 

 

 

 

Goodwill

 

 

1,122,865

 

 

 

1,119,329

 

Intangible assets, net

 

 

60,713

 

 

 

65,561

 

Deferred tax assets

 

 

164,027

 

 

 

150,629

 

Other assets

 

 

13,650

 

 

 

3,444

 

Total assets

 

$

1,661,927

 

 

$

1,483,829

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

15,242

 

 

$

16,687

 

Deferred revenue

 

 

113,820

 

 

 

88,233

 

Short-term operating lease liabilities

 

 

4,986

 

 

 

 

Short-term debt

 

 

9,396

 

 

 

 

Accrued expenses and other current liabilities

 

 

51,033

 

 

 

24,194

 

Total current liabilities

 

 

194,477

 

 

 

129,114

 

Long-term debt

 

 

239,026

 

 

 

 

Deferred revenue, net of current portion

 

 

245,883

 

 

 

265,051

 

Long-term operating lease liabilities

 

 

17,040

 

 

 

 

Other liabilities

 

 

39,286

 

 

 

21,536

 

Total liabilities

 

 

735,712

 

 

 

415,701

 

Commitments and contingencies (Note 10)

 

 

 

 

 

 

 

 

Stockholders' Equity:

 

 

 

 

 

 

 

 

Common stock, $0.01 par value, 600,000,000 shares authorized as of December 31, 2019; 36,403,284 shares issued and outstanding as of December 31, 2019

 

 

364

 

 

 

 

Net parent investment

 

 

-

 

 

 

1,097,127

 

Accumulated other comprehensive loss

 

 

(7,441

)

 

 

(28,999

)

Additional paid-in capital

 

 

945,054

 

 

 

 

Accumulated deficit

 

 

(11,762

)

 

 

 

Total stockholders' equity

 

 

926,215

 

 

 

1,068,128

 

Total liabilities and stockholders' equity

 

$

1,661,927

 

 

$

1,483,829

 

 

Refer to accompanying Notes to the unaudited consolidated and combined financials statements.

4


CERENCE INC.

CONSOLIDATED STATEMENT OF EQUITY AND

COMBINED STATEMENT OF CHANGES IN PARENT COMPANY EQUITY

(Dollars in thousands)

(unaudited)

 

Three Months Ended December 31, 2019

 

 

 

Common Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Additional

Paid-In

Capital

 

 

Accumulated

Deficit

 

 

Net

Parent

Investment

 

 

Accumulated

Other

Comprehensive

Loss

 

 

Total

 

Balance at September 30, 2019

 

 

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

1,097,127

 

 

$

(28,999

)

 

$

1,068,128

 

Net (loss) income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(11,762

)

 

 

-

 

 

 

-

 

 

 

(11,762

)

Other comprehensive income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

5,830

 

 

 

5,830

 

Distribution to Parent

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(152,978

)

 

 

-

 

 

 

(152,978

)

Net (decrease) increase in net parent investment

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(4,275

)

 

 

15,728

 

 

 

11,453

 

Reclassification of net parent investment in Cerence

 

 

-

 

 

 

-

 

 

 

939,874

 

 

 

-

 

 

 

(939,874

)

 

 

-

 

 

 

 

Issuance of common stock at separation

 

 

36,391

 

 

 

364

 

 

 

(364

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

Stock issued pursuant to employee stock plans

 

 

12

 

 

 

0

 

 

 

(141

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(141

)

Stock-based compensation

 

 

-

 

 

 

-

 

 

 

5,685

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

5,685

 

Balance at December 31, 2019

 

 

36,403

 

 

$

364

 

 

$

945,054

 

 

$

(11,762

)

 

$

 

 

$

(7,441

)

 

$

926,215

 

 

 

Three Months Ended December 31, 2018

 

 

 

Common Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Additional

Paid-In

Capital

 

 

Accumulated

Deficit

 

 

Net

Parent

Investment

 

 

Accumulated

Other

Comprehensive

Loss

 

 

Total

 

Balance at September 30, 2018 (As reported, ASC 605)

 

 

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

1,017,276

 

 

$

(23,957

)

 

$

993,319

 

Accumulated adjustment related to the adoption of ASC 606

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

4,735

 

 

 

-

 

 

 

4,735

 

Net income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2,255

 

 

 

-

 

 

 

2,255

 

Other comprehensive loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(3,385

)

 

 

(3,385

)

Net transfer to Parent

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

Balance at December 31, 2018

 

 

-

 

 

$

 

 

$

 

 

$

 

 

$

1,024,266

 

 

$

(27,342

)

 

$

996,924

 

 

Refer to accompanying Notes to the unaudited consolidated and combined financials statements.

5


CERENCE INC.

CONSOLIDATED STATEMENT OF CASH FLOWS FOR THREE MONTHS ENDED DECEMBER 31, 2019

COMBINED STATEMENT OF CASH FLOWS FOR THREE MONTHS ENDED DECEMBER 31, 2018

(Dollars in thousands)

(unaudited)

 

 

 

Three Months Ended December 31,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(11,762

)

 

$

2,255

 

Adjustments to reconcile net (loss) income to net cash provided by operations:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

7,359

 

 

 

7,346

 

Stock-based compensation

 

 

8,969

 

 

 

6,574

 

Non-cash interest expense

 

 

1,332

 

 

 

 

Deferred tax benefit

 

 

(4,928

)

 

 

(1,986

)

Changes in operating assets and liabilities, net of effects from acquisitions:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

1,691

 

 

 

(7,878

)

Prepaid expenses and other assets

 

 

(18,193

)

 

 

6,777

 

Deferred costs

 

 

(192

)

 

 

7

 

Accounts payable

 

 

905

 

 

 

(883

)

Accrued expenses and other liabilities

 

 

22,210

 

 

 

1,117

 

Deferred revenue

 

 

2,065

 

 

 

3,371

 

Net cash provided by operating activities

 

 

9,456

 

 

 

16,700

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(3,612

)

 

 

(498

)

Net cash used in investing activities

 

 

(3,612

)

 

 

(498

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Net transaction with Parent

 

 

11,384

 

 

 

(16,202

)

Distribution to Parent

 

 

(152,978

)

 

 

 

Proceeds from long-term debt, net of discount

 

 

249,705

 

 

 

 

Payments for long-term debt issuance costs

 

 

(515

)

 

 

 

Common stock repurchases for tax withholdings for net settlement of equity awards

 

 

(141

)

 

 

 

Principal payment of lease liabilities arising from a finance lease

 

 

(55

)

 

 

 

Net cash provided by (used in) financing activities

 

 

107,400

 

 

 

(16,202

)

Effects of exchange rate changes on cash and cash equivalents

 

 

152

 

 

 

 

Net change in cash and cash equivalents

 

 

113,396

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

113,396

 

 

$

 

Supplemental information:

 

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

1,472

 

 

$

2,899

 

Cash paid for interest

 

$

3,676

 

 

$

-

 

 

Refer to accompanying Notes to the unaudited consolidated and combined financials statements.

 

6


 

CERENCE INC.

Notes to Consolidated and Combined Financial Statements

Note 1. Business Overview

History

On October 1, 2019, or the “Distribution Date”, Nuance Communications, Inc., or “Nuance”, a leading provider of speech and language solutions for businesses and consumers around the world, completed the complete legal and structural separation and distribution to its stockholders of all of the outstanding shares of our common stock, and its consolidated subsidiaries, in a tax free spin-off (which we refer to as the “Spin-Off”). The distribution was made in the amount of one share of our common stock for every eight shares of Nuance common stock (which we refer to as the “Distribution”) owned by Nuance’s stockholders as of 5:00 p.m. Eastern Time on September 17, 2019, the record date of the Distribution.

In connection with the Distribution, on September 30, 2019, we filed an Amended and Restated Certificate of Incorporation, or the Charter, with the Secretary of State of the State of Delaware, which became effective on October 1, 2019. Our Amended and Restated By-laws also became effective on October 1, 2019. On October 2, 2019, our common stock began regular-way trading on the Nasdaq Global Select Market under the ticker symbol CRNC. 

Business

Cerence Inc. (referred to in this Quarterly Report on Form 10-Q as “we,” “our,” “us,” “ourselves,” the “Company” or “Cerence”) is a global, premier provider of AI-powered assistants and innovations for connected and autonomous vehicles. Our customers include all major automobile original equipment manufacturers, or 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. We generate revenue primarily by selling software licenses and cloud-connected services. In addition, we generate professional services revenue from our work with OEMs and suppliers during the design, development and deployment phases of the vehicle model lifecycle and through maintenance and enhancement projects.

 

Note 2. Significant Accounting Policies

Principals of Consolidation

Fiscal 2020

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

Fiscal 2019

All prior period information is presented on a combined basis. The combined financial statements have been derived from Nuance’s historical accounting records and are presented on a “carve-out” basis to include the historical financial position, results of operations and cash flows applicable to the Cerence business. As a direct ownership relationship did not exist among all the various business units comprising the Cerence business, Nuance’s investment in the Cerence business is shown in lieu of stockholder’s equity in the combined financial statements.

The Combined Statements of Operations include all revenues and costs directly attributable to Cerence as well as an allocation of expenses related to functions and services performed by centralized parent organizations. These corporate expenses have been allocated to the Cerence business based on direct usage or benefit, where identifiable, with the remainder allocated on a pro rata basis of revenues, headcount, number of transactions or other measures as determined appropriate. The Combined Statements of Cash Flows present these corporate expenses that are cash in nature as cash flows from operating activities, as this is the nature of these costs for Nuance. Non-cash expenses allocated from Nuance include corporate depreciation and amortization and stock-based compensation included as add-back adjustments to reconcile net income to net cash provided by operations. Current and deferred income taxes and related tax expense have been determined based on the standalone results of the Cerence business by applying Accounting Standards Codification No. 740, Income Taxes (“ASC 740”), to the Cerence business’s operations in each country as if it were a separate taxpayer (i.e. following the Separate Return Methodology).

7


 

The combined financial statements include the allocation of certain assets and liabilities that have historically been held at the Nuance corporate level or by shared entities but which are specifically identifiable or allocable to the Cerence business. These shared assets and liabilities have been allocated to the Cerence business on the basis of direct usage when identifiable, or allocated on a pro rata basis of revenue, headcount or other systematic measures that reflect utilization of the services provided to or benefits received by Cerence. Nuance uses a centralized approach to cash management and financing its operations. Accordingly, none of the cash, cash equivalents, marketable securities, foreign currency hedges or debt and related interest expense has been allocated to the Cerence business in the combined financial statements. Nuance’s short and long-term debt has not been pushed down to the Cerence business’s combined financial statements because the Cerence business is not the legal obligor of the debt and Nuance’s borrowings were not directly attributable to the Cerence business.

Transactions between Nuance and the Cerence business are considered to be effectively settled in the combined financial statements at the time the transaction is recorded. The total net effect of the settlement of these intercompany transactions is reflected in the Combined Statements of Cash Flows as a financing activity and in the Combined Balance Sheets as net parent investment. All of the allocations and estimates in the combined financial statements are based on assumptions that management believes are reasonable.

Basis of Presentation

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete financial statements.

The consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the consolidated results of operations and financial position for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three months ended December 31, 2019 are not necessarily indicative of the results to be expected for any other interim period or for the year ending September 30, 2020. These unaudited interim consolidated financial statements should be read in conjunction with the audited combined financial statements and notes contained in our Annual Report on Form 10-K for the year ended September 30, 2019.

Use of Estimates

The financial statements are prepared in accordance with GAAP, which requires management to make estimates and assumptions. These estimates, judgments and assumptions can affect the reported amounts in the financial statements and the footnotes thereto. Actual results could differ materially from these estimates.

On an ongoing basis, we evaluate our estimates, assumptions and judgments. Significant estimates inherent to the preparation of financial statements include: revenue recognition; the allowances for doubtful accounts; accounting for deferred costs; accounting for internally developed software; the valuation of goodwill and intangible assets; accounting for business combinations; accounting for stock-based compensation; accounting for income taxes, deferred tax assets, and related valuation allowances; and loss contingencies. We base our estimates on historical experience, market participant fair value considerations, projected future cash flows, and various other factors that are believed to be reasonable under the circumstances. Actual amounts could differ significantly from these estimates.

Recently Adopted Accounting Standards

Leases

In February 2016, the FASB issued ASU No. 2016-02, “Leases” (“ASU 2016-02”), and codified as ASC 842, which became effective for fiscal years beginning after December 15, 2018 and interim periods therein, with early adoption permitted. The guidance requires lessees to recognize on the balance sheet a right-of-use, or ROU, asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases.

In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to “Topic 842, Leases” and ASU 2018-11, “Leases Topic Targeted Improvements”, which provides an additional and optional transition method whereby the new lease standard is applied at the adoption date and recognized as an adjustment to retained earnings. Additionally, in March 2019, the FASB issued ASU 2019-01, “Codification Improvements to Topic 842”, which provides guidance in the following areas: (1) determining the fair value of the underlying asset by lessors that are not manufacturers or dealers and (2) clarification of interim disclosure requirements during transition.

8


 

We adopted the new standard effective October 1, 2019 under the modified retrospective transition approach. Results for reporting periods beginning after October 1, 2019 are presented under ASC 842, while prior periods have not been adjusted and continue to be reported in accordance with our historic accounting under previous GAAP. We elected the package of practical expedients permitted under the transition guidance. The new standard does not have a material impact on our consolidated statement of operations and cash flows. Approximately $2.2 million of deferred rent balances were reclassified against the costs of the right of use assets. The effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of October 1, 2019 is immaterial.

The following tables summarize the impact of adopting ASC 842 on the consolidated balance sheet as of October 1, 2019 (dollars in thousands):

 

 

 

As of October 1, 2019

 

 

 

As Previously

Reported

 

 

Impact of Adoption

of Topic ASC 842

 

 

As Adjusted

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease right of use assets

 

$

 

 

$

19,594

 

 

$

19,594

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Short-term operating lease liabilities

 

$

 

 

$

4,863

 

 

$

4,863

 

Accrued expenses and other current liabilities

 

 

24,194

 

 

 

(1,465

)

 

 

22,729

 

Long-term operating lease liabilities

 

 

-

 

 

 

16,883

 

 

 

16,883

 

Other liabilities

 

$

21,536

 

 

$

(687

)

 

$

20,849

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

 

 

 

 

 

 

 

Net parent investment

 

$

1,097,127

 

 

$

-

 

 

$

1,097,127

 

 

Other Accounting Pronouncements

In August 2018, the FASB issued ASU No. 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”, which is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The guidance requires that implementation costs related to a hosting arrangement that is a service contract be capitalized and amortized over the term of the hosting arrangement, starting when the module or component of the hosting arrangement is ready for its intended use. The adoption of ASU 2018-15 did not have a material impact on our consolidated financial statements.

 

Note 3. Revenue Recognition

We primarily derive revenue from the following sources: (1) royalty-based software license arrangements, (2) connected services, and (3) professional services. Revenue is reported net of applicable sales and use tax, value-added tax and other transaction taxes imposed on the related transaction including mandatory government charges that are passed through to our customers. We account for a contract when both parties have approved and committed to the contract, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

Our arrangements with customers may contain multiple products and services. We account for individual products and services separately if they are distinct—that is, if a product or service is separately identifiable from other items in the contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer.

We currently recognize revenue after applying the following five steps:

 

identification of the contract, or contracts, with a customer;

 

identification of the performance obligations in the contract, including whether they are distinct within the context of the contract;

 

determination of the transaction price, including the constraint on variable consideration;

9


 

 

allocation of the transaction price to the performance obligations in the contract;

 

recognition of revenue when, or as, performance obligations are satisfied.

We allocate the transaction price of the arrangement based on the relative estimated standalone selling price (“SSP”) of each distinct performance obligation. In determining SSP, we maximize observable inputs and consider a number of data points, including:

 

the pricing of standalone sales (in the instances where available);

 

the pricing established by management when setting prices for deliverables that are intended to be sold on a standalone basis;

 

contractually stated prices for deliverables that are intended to be sold on a standalone basis; and

 

other pricing factors, such as the geographical region in which the products are sold and expected discounts based on the customer size and type.

We only include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. We reduce transaction prices for estimated returns and other allowances that represent variable consideration under ASC 606, which we estimate based on historical return experience and other relevant factors, and record a corresponding refund liability as a component of accrued expenses and other current liabilities. Other forms of contingent revenue or variable consideration are infrequent.

Revenue is recognized when control of these services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services.

We assess the timing of the transfer of products or services to the customer as compared to the timing of payments to determine whether a significant financing component exists. In accordance with the practical expedient in ASC 606-10-32-18, we do not assess the existence of a significant financing component when the difference between payment and transfer of deliverables is a year or less. If the difference in timing arises for reasons other than the provision of finance to either the customer or us, no financing component is deemed to exist. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our services, not to receive or provide financing from or to customers. We do not consider set-up fees nor other upfront fees paid by our customers to represent a financing component.

Reimbursements for out-of-pocket costs generally include, but are not limited to, costs related to transportation, lodging and meals. Revenue from reimbursed out-of-pocket costs is accounted for as variable consideration.

(a) Performance Obligations

Licenses

Software and technology licenses sold with non-distinct professional services to customize and/or integrate the underlying software and technology are accounted for as a combined performance obligation. Revenue from the combined performance obligation is recognized over time based upon the progress towards completion of the project, which is measured based on the labor hours already incurred to date as compared to the total estimated labor hours. For income statement presentation purposes, we separate license revenue from professional services revenue based on their SSPs.

Revenue from distinct software and technology licenses, which do not require professional service to customize and/or integrate the software license, is recognized at the point in time when the software and technology is made available to the customer and control is transferred.

Revenue from software and technology licenses sold on a royalty basis, where the license of non-exclusive intellectual property is the predominant item to which the royalty relates, is recognized in the period the usage occurs in accordance with the practical expedient in ASC 606-10-55-65(A).

10


 

Connected Services

Connected services, which allow our customers to use the hosted software over the contract period without taking possession of the software, are provided on a usage basis as consumed or on a fixed fee subscription basis. Subscription basis revenue represents a single promise to stand-ready to provide access to our connected services. Our connected services contract terms generally range from one to five years.

As each day of providing services is substantially the same and the customer simultaneously receives and consumes the benefits as access is provided, we have determined that our connected services arrangements are a single performance obligation comprised of a series of distinct services. These services include variable consideration, typically a function of usage. We recognize revenue as each distinct service period is performed (i.e., recognized as incurred).

Our connected service arrangements generally include services to develop, customize, and stand-up applications for each customer. In determining whether these services are distinct, we consider dependence of the Cloud service on the up-front development and stand-up, as well as availability of the services from other vendors. We have concluded that the up-front development, stand-up and customization services are not distinct performance obligations, and as such, revenue for these activities is recognized over the period during which the cloud-connected services are provided, and is included within connected services revenue.

Professional Services

Revenue from distinct professional services, including training, is recognized over time based upon the progress towards completion of the project, which is measured based on the labor hours already incurred to date as compared to the total estimated labor hours.

(b) Significant Judgments

Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Our license contracts often include professional services to customize and/or integrate the licenses into the customer’s environment. Judgment is required to determine whether the license is considered distinct and accounted for separately, or not distinct and accounted for together with professional services.

Judgments are required to determine the SSP for each distinct performance obligation. When the SSP is directly observable, we estimate the SSP based upon the historical transaction prices, adjusted for geographic considerations, customer classes, and customer relationship profiles. In instances where the SSP is not directly observable, we determine the SSP using information that may include market conditions and other observable inputs. We may have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Determining the SSP for performance obligations which we never sell separately also requires significant judgment. In estimating the SSP, we consider the likely price that would have resulted from established pricing practices had the deliverable been offered separately and the prices a customer would likely be willing to pay.

(c) Disaggregated Revenue

Through the evaluation of the discrete financial information that is reviewed by the chief operating decision maker (our chief executive officer), we have determined that we have one reportable segment.

Revenues, classified by the major geographic region in which our customers are located, for the three months ended December 31, 2019 and 2018 (dollars in thousands):

 

 

 

Three Months Ended December 31,

 

 

 

2019

 

 

2018

 

Revenues:

 

 

 

 

 

 

 

 

United States

 

$

35,041

 

 

$

38,064

 

Other Americas

 

 

8

 

 

 

354

 

Germany

 

 

20,217

 

 

 

13,716

 

Other Europe, Middle East and Africa

 

 

4,597

 

 

 

4,784

 

Japan

 

 

11,411

 

 

 

9,753

 

Other Asia-Pacific

 

 

6,185

 

 

 

5,813

 

Total net revenues

 

$

77,459

 

 

$

72,484

 

 

11


 

Revenues within the United States, Germany, and Japan accounted for more than 10% of revenue for all periods presented.

Revenues relating to one customer accounted for $18.0 million, or 23.2% of revenue for the three months ended December 31, 2019. Two customers accounted for $13.5 million, or 18.7%, and $8.1 million, or 11.2% of revenue for the three months ended December 31, 2018.

(d) Contract Acquisition Costs

In conjunction with the adoption of ASC 606, we are required to capitalize certain contract acquisition costs. The capitalized costs primarily relate to paid commissions. In accordance with the practical expedient in ASC 606-10-10-4, we apply a portfolio approach to estimate contract acquisition costs for groups of customer contracts. We elect to apply the practical expedient in ASC 340-40-25-4 and will expense contract acquisition costs as incurred where the expected period of benefit is one year or less. Contract acquisition costs are deferred and amortized on a straight-line basis over the period of benefit, which we have estimated to be, on average, between one and five years. The period of benefit was determined based on an average customer contract term, expected contract renewals, changes in technology and our ability to retain customers, including canceled contracts. We assess the amortization term for all major transactions based on specific facts and circumstances. Contract acquisition costs are classified as current or noncurrent assets based on when the expense will be recognized. The current and noncurrent portions of contract acquisition costs are included in prepaid expenses and other current assets, and in other assets, respectively. As of December 31, 2019, we had $2.1 million of contract acquisition costs. We had amortization expense of $0.2 million related to these costs during the three months ended December 31, 2019. There was no impairment related to contract acquisition costs.

(e) Capitalized Contract Costs

We capitalize incremental costs incurred to fulfill our contracts that (i) relate directly to the contract, (ii) are expected to generate resources that will be used to satisfy our performance obligation under the contract, and (iii) are expected to be recovered through revenue generated under the contract. Our capitalized costs consist primarily of setup costs, such as costs to standup, customize and develop applications for each customer, which are incurred to satisfy our stand-ready obligation to provide access to our connected offerings. These contract costs are expensed to cost of revenue as we satisfy our stand-ready obligation over the contract term which we estimate to be between one and five years, on average. The contract term was determined based on an average customer contract term, expected contract renewals, changes in technology, and our ability to retain customers, including canceled contracts. We classify these costs as current or noncurrent based on the timing of when we expect to recognize the expense. The current and noncurrent portions of capitalized contract fulfillment costs are presented as deferred costs. As of December 31, 2019, we had $43.0 million of capitalized contract costs.

We had amortization expense of $2.7 million related to these costs during the three months ended December 31, 2019. There was no impairment related to contract costs capitalized

(f) Trade Accounts Receivable and Contract Balances

We classify our right to consideration in exchange for deliverables as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional (i.e. only the passage of time is required before payment is due). We present such receivables in accounts receivable, net at their net estimated realizable value. We maintain an allowance for doubtful accounts to provide for the estimated amount of receivables that may not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience, the age of outstanding receivables and other applicable factors.

Our contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period.

Contract assets include unbilled amounts from long-term contracts when revenue recognized exceeds the amount billed to the customer, and right to payment is not solely subject to the passage of time. Contract assets are included in prepaid expenses and other current assets. The table below shows significant changes in contract assets (dollars in thousands):

 

 

 

Contract assets

 

Balance as of October 1, 2019

 

$

9,219

 

Revenues recognized but not billed

 

 

19,524

 

Amounts reclassified to accounts receivable, net

 

 

(5,765

)

Balance as of December 31, 2019

 

$

22,978

 

 

12


 

Our contract liabilities, which we present as deferred revenue, consist of advance payments and billings in excess of revenues recognized. We classify deferred revenue as current or noncurrent based on when we expect to recognize the revenues. The table below shows significant changes in deferred revenue (dollars in thousands):

 

 

 

Deferred revenue

 

Balance as of October 1, 2019

 

$

353,284

 

Amounts billed but not recognized

 

 

31,663

 

Revenue recognized

 

 

(25,244

)

Balance as of December 31, 2019

 

$

359,703

 

 

(g) Remaining Performance Obligations

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied at December 31, 2019 (dollars in thousands):

 

 

 

Within One

Year

 

 

Two to Five

Years

 

 

Greater

than

Five Years

 

 

Total

 

Total revenue

 

$

156,695

 

 

$

155,875

 

 

$

98,423

 

 

$

410,993

 

 

The table above includes fixed backlogs and does not include variable backlogs derived from contingent usage-based activities, such as royalties and usage-based connected services.

 

Note 4. Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potential dilutive shares of common stock been issued. The dilutive effect of restricted stock units are reflected in diluted net income per share by applying the treasury stock method. Due to the net loss recognized for the three months ended December 31, 2019, there were no dilutive shares. There were no Cerence equity awards outstanding prior to the Spin-Off, thus the computation of basic and diluted earnings per common share (EPS) for all prior periods disclosed was calculated using the shares issued in connection with the Spin-Off  totaling 36.4 million shares.  

The numerator for both basic and diluted EPS is net (loss) income.

The following is a reconciliation of basic shares to diluted shares:

 

 

 

December 31,

 

in thousands

 

2019

 

 

2018

 

Basic shares

 

 

35,995

 

 

 

36,391

 

Effect of dilutive shares

 

 

 

 

 

 

Diluted shares

 

 

35,995

 

 

 

36,391

 

 

Note 5. Goodwill and Other Intangible Assets

(a) Goodwill

The changes in the carrying amount of goodwill as of December 31, 2019 are as follows (dollars in thousands):

 

 

 

Total

 

Balance as of October 1, 2019

 

$

1,119,329

 

Acquisitions

 

 

 

Effect of foreign currency translation

 

 

3,536

 

Balance as of December 31, 2019

 

$

1,122,865

 

 

13


 

(b) Intangible Assets, Net

The following tables summarizes the gross carrying amounts and accumulated amortization of intangible assets by major class (dollars in thousands):

 

 

 

December 31, 2019

 

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Amount

 

 

Weighted Average

Remaining Life

(Years)

 

Customer relationships

 

$

108,863

 

 

$

(65,369

)

 

$

43,494

 

 

 

3.7

 

Technology and patents

 

 

90,174

 

 

 

(72,955

)

 

 

17,219

 

 

 

2.3

 

Total

 

$

199,037

 

 

$

(138,324

)

 

$

60,713

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Amount

 

 

Weighted Average

Remaining Life

(Years)

 

Customer relationships

 

$

104,783

 

 

$

(58,568

)

 

$

46,215

 

 

 

4.0

 

Technology and patents

 

 

116,757

 

 

 

(97,411

)

 

 

19,346

 

 

 

2.5

 

Total

 

$

221,540

 

 

$

(155,979

)

 

$

65,561

 

 

 

 

 

 

Amortization expense related to intangible assets in the aggregate was $5.2 million and $5.3 million for the three months ended December 31, 2019 and 2018, respectively. We expect amortization of intangible assets to be $15.5 million for the remainder of 2020.

 

Note 6. Leases

We have entered into a number of facility leases to support our research and development activities, sales operations, and other corporate and administrative functions in North America, Europe, and Asia, which qualify as operating leases under GAAP. We also have a limited number of equipment leases that also qualify as operating leases. We determine if contracts with vendors represent a lease or have a lease component under GAAP at contract inception. As part of our acquisition of Voicebox Technologies, or Voicebox, we assumed certain leases for various equipment, which we have accounted for as finance leases. Our leases have remaining terms ranging from less than one year to eight years. Some of our leases include options to extend or terminate the lease prior to the end of the agreed upon lease term. For purposes of calculating lease liabilities, lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise such options.

Operating lease right of use assets and liabilities are recognized based on the present value of the future minimum lease payments over the lease term at the lease commencement date. As our leases generally do not provide an implicit rate, we use an estimated incremental borrowing rate in determining the present value of future payments. The incremental borrowing rate represents an estimate of the interest rate we would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease within a particular location and currency environment.

The following table presents certain information related to lease term and incremental borrowing rates for leases as of December 31, 2019:

 

 

 

December 31, 2019

 

Weighted-average remaining lease term (in months):

 

 

 

 

Operating leases

 

 

59.7

 

Finance leases

 

 

1.0

 

Weighted-average discount rate:

 

 

 

 

Operating leases

 

 

8.0

%

Finance leases

 

 

10.6

%

 

14


 

The following table presents the lease-related assets and liabilities reported in the consolidated balance sheet as of December 31, 2019 (in thousands):

 

 

 

Classification

 

December 31, 2019

 

Assets

 

 

 

 

 

 

Operating lease assets

 

Operating lease right of use assets

 

$

19,681

 

Finance lease assets

 

Property and equipment, net

 

 

253

 

Total lease assets

 

 

 

$

19,934

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

Current

 

 

 

 

 

 

Operating

 

Short-term operating lease liabilities

 

$

4,986

 

Finance

 

Accrued expenses and other current liabilities

 

 

12

 

Noncurrent