Earnings Call Transcript - CRNC Q1 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to Cerence’s First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's call is being recorded. I would now like to hand the call over to Richard Yerganian, Vice President of Investor Relations for Cerence. Please go ahead.

Richard Yerganian, Vice President of Investor Relations

Thank you, Michelle. Welcome to Cerence's First Quarter Fiscal Year 2021 Conference Call. Before we begin, I would like to remind you that this call may involve certain forward-looking statements. These statements are subject to risks and uncertainties as described in the press release preceding today's call. Cerence makes no representations to update those statements after the date hereof. In addition, the Company may refer to certain non-GAAP measures, key performance indicators and pro forma financial information during this call. Please refer to today's press release for further details of the definitions, limitations and uses of those measures and reconciliations of non-GAAP measures to the closest GAAP equivalent. Joining me on today's call are Sanjay Dhawan, President and CEO of Cerence; and Mark Gallenberger, CFO of Cerence. As a reminder, the only authorized spokespeople for the Company are Sanjay, Mark, and me. While many were amazed by our voice cloning technology last quarter, Sanjay and Mark will be live for the prepared remarks and Q&A, and I challenge you to be able to tell the difference from last quarter's conference call to this one. Before handing the call over to Sanjay, I would like to announce several upcoming investor events. They are all virtual events, so the exact timing of our participation is subject to change. The conferences include this Wednesday, the 2021 Goldman Sachs Tech and Internet Conference on February 10; and in March, we plan to participate in the Berenberg Capital Industrial Technology Conference, the Raymond James 42nd Annual Institutional Investor Conference, Baird's 2021 Vehicle Technology and Mobility Conference, and the Cowen Mobility Disruption Summit. Please visit the Events page in our Investors section of Cerence's website for the most up-to-date information on our participation. Now, onto the call. Sanjay?

Sanjay Dhawan, President and CEO

Thank you, Rich. It's great to be live this time. Welcome to everyone on the call, and thank you for joining us to discuss our first quarter fiscal 2021 results. I will first review our strong performance in Q1, followed by a summary of the key product introductions during the quarter. This will be followed by comments about the near-term business environment and an update on our key performance indicators, and then I'll hand the call over to Mark to review the detailed financial results. After a record fiscal year in 2020, we are off to a fast start in fiscal 2021 as our initiatives for innovation and market expansions continue. In Q1, we again delivered record revenue of $95 million, representing 23% year-over-year growth. Our performance was driven by strong growth in our license, connected services, and professional services businesses. While revenue growth is an important metric for the Company, I'm extremely proud of how we drive the business to achieve profitable revenue growth. Our intense focus on this led to a non-GAAP gross margin of 75%, adjusted EBITDA of approximately $40 million or 42% margin, and non-GAAP EPS was a strong $0.59. Overall, our Q1 results surpassed expectations in every key financial metric, and Mark will share the details later in the call. You may have seen our recent announcement further strengthening our professional services organization by hiring Sujal Shah to lead this group. Sujal comes to us from Harman and has extensive experience in the automotive space, particularly in creating new service offerings that will lead to even more future growth opportunities in this part of our business. I want to welcome Sujal and wish him the best. As strong as our financial results were for the quarter, there were many non-financial highlights as well. One of the key achievements in the quarter was that we were awarded a design win for a major European OEM's next-generation infotainment system, expected to start production in 2023. We just received the okay to share the deal, and the name of the European OEM is Stellantis. It is one of the top three auto OEMs that was recently formed by the combination of FCA and PSA. This win is important for two reasons. First, we won back a customer that had been lost to a competitor when our business was still part of Nuance. Second, the deal includes many of the latest connected services and apps product offerings we announced just a couple of weeks ago at our Cerence in Motion event, a true testament of the strength of our new offerings and innovative technology. Another headline event was our agreement with Xevo, a Lear Company, to deliver Cerence Pay, conversational AI-powered contactless payments into vehicles via the Xevo market platform. This deal is significant because it represents a major booking for one of our new Cerence apps. The bookings-to-revenue cycle for these offerings is much shorter than our standard products, so we expect to see revenue from this deal before the end of the calendar year. It is our speed of innovation and execution that allows us to retain or win new design opportunities, and that capability was clearly on display at our Cerence in Motion event. During this event, we introduced amazing technology that represents best-in-class or brand-new capabilities focused on extending a driver's full digital life from outside the car to inside the car. We introduced Cerence Drive 2.0, a major upgrade to our core technology. Cerence Drive 2.0 features a combination of edge technology enhancements and improved and expanded connected cloud services capabilities. Whether it's the number of languages we support, the level of accuracy, the speed of response, or the human-like text-to-speech capability, we're confident that Cerence Drive 2.0 represents the very best of conversational AI technology available in the mobility market. During the Cerence in Motion event, we also introduced a series of other new products. Cerence Extend provides the ability for a driver to use their voice to control apps on their Android or iOS-based smartphones. Cerence Extend removes the limitation of using your voice for a defined subset of apps on your phone and allows you to use your voice to control apps ranging from Microsoft Teams to ordering a coffee through your Starbucks app. This product plays a significant role in extending the consumer's full digital life from outside the car to inside the car. No one else offers this technology. To truly extend one's digital life into the car also means providing a seamless way for a driver to interact with smart home and IoT systems. This is exactly what Cerence Connect allows you to do using your voice. Supporting multiple IoT and big tech ecosystems, Cerence Connect allows the user to provide simple instructions or create custom smart home routines or rules. Even if you use different ecosystems within your home, Cerence Connect allows you to control them through one AI interface. Cerence Tour Guide is a new application that serves as a high-quality professional tour guide in your car, whether selecting a pre-planned trip or using the application on-the-go, Cerence Tour Guide can inform the user about the key points of interest and also book experiences like restaurants, museums, and other attractions. Cerence Look is a new product that has the capability to leverage gaze technology and/or the GPS location of the car to provide information on points of interest along the road. The technology was recently demonstrated by Mercedes-Benz as its travel knowledge product, which allows a driver to ask about the point of interest outside the car, and the voice assistant responds with the information describing their point of interest. Cerence Look is currently in production now. Cerence Browse provides the intelligence of Internet search engines in the car using conversational AI. Cerence Browse connects to multiple sources in real-time, indexes continuously updated information from Internet sources, and uses machine reading comprehension to deliver the best possible response. As I said earlier, innovation is key to our growth and competitive advantages. But innovation alone isn't enough; it's the ability to bring those innovations to market quickly with the highest quality and to meet or surpass the requirements of our customers. I'm happy to report we had several awards during the quarter, recognizing the contributions that the Cerence team has made to conversational AI technology in the car, and one, from a customer recognizing the value of Cerence as a partner. While we value the recognition from customers, the one we received from Baidu is worth mentioning for two reasons. First, Cerence was the only automotive supplier that Baidu recognized for their 2020 awards. Second, it's another example of how it's a story of Cerence and big tech, not Cerence or big tech. As part of the Cerence event, we also formally launched conversational AI-based platforms for two adjacent markets that we have been targeting, the two-wheeler and building mobility markets. There are approximately 90 million two-wheel vehicles produced every year, and we see the opportunity to penetrate this market with a truly unique solution. As we have mentioned before, we received our first win in this space late in fiscal 2020, and we believe we are well-positioned for additional wins this fiscal year. In the elevator market, we have made significant progress, completing proof-of-concept demonstrations with two of the top five elevator manufacturers in the world. The key to this business is that our product is capable of being retrofitted into existing elevators as well as incorporated into new installations. We are optimistic that we will have multiple elevator customers this fiscal year. Just the innovation, expansion, and acceptance that I just discussed, our KPI continued to show good progress, and I'll highlight two in particular. The first was related to our average billings per car, which increased 20% year-over-year on a trailing 12-month basis. We previously compared year-to-date results to the prior fiscal year, but now are reporting on a trailing 12-month basis to provide a more accurate picture of the trends in the billings per car. The other noteworthy KPI was that our adoption metrics continue to show a strong recovery following the impact of COVID in the middle part of last year. We would expect this positive trend to continue. We continue to see excitement from our customers about our product innovations, and our long-term growth opportunities remain bright. In summary, the momentum created during our first year as an independent company continued into our second year. We believe the innovative technology that we have brought to the market will keep the momentum going. Our focus has been on driving our AI to enhance the experience in a safer, more productive way. We will continue to expand in-cabin AI using voice and increasingly other modalities. Longer term, we look for opportunities where we can apply our AI skills into other areas like Road AI. We have a long-term vision for the future of transportation and mobility, and I'm very excited about the role Cerence will play. I would like to turn the call over to Mark to review the financial results of the quarter and our guidance for Q2 and for the year. Mark?

Mark Gallenberger, CFO

Thank you, Sanjay. I'll first review the strong performance for the first quarter, and then I'll provide guidance for our second quarter and an update for the full year. Once again, our results came in stronger than expected, leading us to another record revenue for the quarter. Revenue came in at $95 million, which is $5 million above the high end of our guidance and is a 23% increase from the same period last year. Our profitability metrics were very strong, and they all exceeded the high end of our guidance range. The non-GAAP gross margin was 75.3%. Non-GAAP operating margin was 39.7%. Adjusted EBITDA came in at $40.3 million or 42.4% margin, and non-GAAP earnings per share was $0.59. The Q1 results are still benefiting from the cost savings that we implemented due to COVID last year. As previously mentioned, these cost savings will return during the course of this fiscal year. However, we believe that some of the gross margin improvements that we have seen in our connected services and professional services businesses are sustainable into the future, and these improvements will be reflected in our long-term model that we intend to update later this year. During the quarter, we generated approximately $11 million of CFFO, and our balance sheet remains strong with total cash and marketable securities at $127 million. During the quarter, we successfully renegotiated our Term Loan A with our banking partners, which is estimated to save the Company $1 million in annual cash interest expense. The key changes were a lowering of the interest rate spread by 50 basis points, removing the LIBOR fixed floor of 50 basis points, and extending the maturity by 10 months to April 2025. Now, let's review in more detail our revenue performance for the quarter. The record revenue was driven by three factors. First, our variable license product revenue was up 21% from last quarter and up 8% from last year, driven by a continued strong recovery in auto production since hitting the trough in the April-May timeframe of last year due to COVID. Second, our new connected services revenue expanded 24% from last quarter and was up 55% year-over-year due to a continually expanding customer base adopting our new connected service offerings. And third, our professional services business grew 9% from last quarter and was also up 55% from last year, driven by an increase in engineering activity in order to get customers ready for their start of production. Additionally, our professional services revenue was higher than expected in the quarter due to the early completion of customer projects that resulted in an acceleration of about $2 million of revenue into Q1. Moving on to our Q2 guidance. Our revenue guidance for the second quarter of $92 million to $95 million reflects year-over-year growth of 6% to 10% and takes into consideration the current risks and uncertainties of the semiconductor device shortages that are impacting auto production. According to IHS Market, the semiconductor shortage issues are expected to be resolved by mid-calendar year, and IHS does not expect an impact to its full year forecast, but rather a shift to the second half of the calendar year. Due to our higher year-over-year revenue guidance for Q2 and the continued cost benefits from the expense reductions taken last year due to COVID, we are expecting all of our Q2 non-GAAP profit margin metrics to be up by 240 to 500 basis points versus the same period last year. For the fiscal year, we are updating our guidance to reflect our stronger-than-expected first quarter revenue and margin performance and also consider the risks and uncertainties surrounding the semiconductor device shortages that I previously mentioned. Therefore, we are raising the bottom end of our guidance from $360 million to $370 million and keeping the high end at $380 million, which raises the midpoint of revenue to $375 million. Also due to our continued strong profit performance, we have also increased all of our profit margin metrics by up to 200 basis points. Specifically, we increased non-GAAP gross margin to 74% to 75%, non-GAAP operating margin to 33% to 35%, adjusted EBITDA to 35% to 37%, non-GAAP EPS to $1.91 to $2.10, and CFFO to be in the range of $67 million to $72 million for the year. Adjusted EBITDA for the full year is expected to be in the range of $131 million to $140 million, which is up from our original guidance of $122 million to $135 million due to better-than-expected profitability and the updated revenue guidance. Please refer to our earnings press release or the appendix of this presentation for more details of our guidance as well as our GAAP to non-GAAP reconciliation tables. So in summary, the business delivered another solid quarter. Our new products and technologies continue to enhance our competitive position, enabling us to maintain our strong market share. The business model continues to perform well, as evidenced by our Q1 results and by raising our revenue and profit metrics for the year. A combination of strength in our core business along with opportunities for new business from our new products and adjacent markets presents a bright future for Cerence. This concludes our prepared remarks, and now we will open it up for questions.

Operator, Operator

Our first question comes from Joseph Spak with RBC Capital Markets. Your line is open.

Joseph Spak, Analyst

Thanks very much for the question. Sanjay, I just want to start talking about how you see the market evolving because I know nothing changes on your current programs or wins. But since the beginning of this year, we saw Amazon at CES talk about selling the underlying access to Alexa to companies, including Stellantis. Ford moved to Android OS, and that obviously comes with Google Voice. And then on the earnings call, they talked about integrating Alexa. So I know in both of those instances, there's nothing that precludes Cerence from being integrated. But it does seem like on the next-gen, automakers might have more options going forward. How do you view that development, and what, in your view, is the killer feature that keeps Cerence with the automakers and potentially, more importantly, the customers using Cerence services?

Sanjay Dhawan, President and CEO

Sure. From my perspective, there’s nothing new to add. Since the inception of our company, we have maintained that multiple big tech companies can coexist in vehicles. It would be misguided to assume that the 22 hours I spend outside the car equates to a separate digital experience when I’m in the car. That’s not how it works. Users always desire a seamless experience. Additionally, we’ve consistently stated that the big tech ecosystem isn’t confined to just one major player. I encourage anyone to reflect on their own digital life; they will see that it encompasses Amazon, Google, Apple, Microsoft, and more. The main reason for this coexistence is our collaboration with OEMs to provide a comprehensive and independent multi-big tech ecosystem, primarily facilitated through voice technology. This remains a key aspect of our appeal. As for the opportunities mentioned, our products, like Connect, integrate with various platforms beyond just Apple’s IoT ecosystem or Amazon, Google, Samsung SmartThings, LG ThinQ, and others; we cover it all. This comprehensive approach strengthens our position.

Joseph Spak, Analyst

I guess, my second question would just be on the guidance, and you mentioned the semiconductor shortage. IHS is calling for recovery in the second half, although it does seem like expectations there might be slipping a little bit. But you don't have the benefit of that December quarter that they're counting on in your guidance. I think it looks impressive here that you're able to, as you pointed out, Mark, raise the midpoint. Can you just walk through maybe the offset there, what you're seeing more organically that's giving you that confidence?

Mark Gallenberger, CFO

Yes. So, I think the increasing penetration rates — we see that continuing trend like in the past. And so that's not slowing down. Regardless of what's happening with short-term auto production, those penetration rates, not only on the embedded but also on connected are continuing. So I think that gives us comfort that we are still growing above the auto SAAR. Last year, we had a phenomenal year, well above auto production, which was down 19%, when our business was up about 9% year-over-year. This year, we are forecasting us to be higher as well, above what's happening with auto production. But I think it really comes down to the technology and the increasing secular tailwind that we're enjoying in the auto space.

Operator, Operator

Our next question comes from Raji Gill with Needham & Company. Your line is open.

Rajvindra Gill, Analyst

Yes. Congrats on excellent momentum in your business and in the marketplace. It's quite impressive. The growth that you're seeing in professional services has been consistent and improving. How do you think about that business line this year, but also in the future about growing that business? Along those lines, how do we think about the margins in that business? I know you talked about improving that. What are the drivers to improving the margins on the services line?

Mark Gallenberger, CFO

Sure. I can start, and Sanjay, if you want to add some color. I'll start on the margin side. We are making improvements that we think are sustainable. Those improvements are really around shifting some of the actual activities that are being done into lower-cost locations, specifically in India and China. We think those improvements or changes are going to help us improve the gross margins of our pro services, which we believe will be sustainable. As I mentioned earlier, we do plan to update our longer-term target model with some improved margin assumptions for the pro services business in addition to the Connected. We just want to give ourselves a little bit more time to make sure that the new business model proves itself out before we reset expectations on those assumptions. I think Sanjay might want to talk a little bit about the revenue?

Sanjay Dhawan, President and CEO

Yes. So Raji, the main reason for our Professional Services (PS) business is to strongly support our product integration into our customers' products. So, we stay very focused on that. Those integrations exist in the car and also in the cloud. We continue to expand our PS footprint around all of that. But remember, our core focus is our product business. Our license, the SaaS cloud services, and so on. While PS is contributing strongly, I am very happy for that, and I'm very proud of the PS team for improving the gross margins and expanding, because the car is getting more digital, which leads to more integrations needed with not just voice. The interesting thing about voice and conversational AI is it touches every part of the connected car. We do get involved in various integrations, including with vision and other new technologies coming into the car and other new sensors. We'll continue to do that. The opportunities are huge in PS, but we stay focused on making sure that PS supports our core product integrations.

Rajvindra Gill, Analyst

And Mark, there was a 39% sequential drop in fixed prepay. Obviously, that business is lumpy. How do you think about prepay this year?

Mark Gallenberger, CFO

Yes. So prepays can be lumpy. It's more concentrated. As we've seen in the past, they can go up and down. Last year, we did about $54 million in prepays, and we do expect prepays to be down this year. We've historically been in that range of low 40s to low 50s, and I think we're going to stay in that range. So last year, we were at the higher end of that range, and this year, I would estimate we'll probably be around the middle.

Rajvindra Gill, Analyst

And last question, Sanjay. How do you think about increasing ASP growth for your services? You're obviously providing tremendous value to the OEM. You enable a myriad of applications. Yet, the ASPs are still fairly low compared to other services in the business. So, what are the steps you're taking to improve the ASPs and when do you think we'll see that improvement?

Sanjay Dhawan, President and CEO

So Raji, the core business model was set in a certain way when I first stepped in as the CEO about 15 months back now. What we are doing very systematically is to enhance that core business model. We cannot change that core business model overnight, as it's been in existence for many years, and OEMs are used to buying in a certain way. The core of our increasing the ASP strategy is through new products and innovations. I cannot be more proud of how our product management and R&D teams have executed over the last year. I hope you have seen the Cerence in Motion event; we brought our new product innovations out, and these are not just announcements. We have multiple design wins on these, which will show up as increased ASP and increased revenue in the coming quarters and years. The cycle is slower, given how auto works, but we’re trying very hard to accelerate our apps business to contribute revenue earlier. We are making progress and working hard.

Operator, Operator

Our next question comes from Mark Delaney with Goldman Sachs. Your line is open.

Mark Delaney, Analyst

I was hoping first to follow up about the co-existence with big tech companies, and the Company talked about seeing good evidence of that. But could you elaborate a bit more and talk about how you're seeing your content per vehicle trend when you are in one of those co-existence types versus being more of a standalone technology? What sort of price can you get for your technology if other services are also being offered in the car? I realize the Company is doing a lot of new technologies, which are additional monetization opportunities. So if you could help investors sort those out, perhaps some examples would be helpful?

Sanjay Dhawan, President and CEO

Sure. We have not seen any major swings from a co-existence standpoint. Mark, you can jump in after me, but I'm just thinking about almost a dozen cars or so that we coexist with big tech or not. We've been able to maintain our pricing position with the value we add and then buy our products. The strategy, Mark, is to obviously expand with all the new cloud services and apps and other offerings. There are some new discussions happening with a couple of OEMs which are also from a co-existence standpoint, but those are too early for me to comment on pricing impact. Our goal is to maintain and enhance the core tech and the expanded products and technologies. Mark, do you want to add anything?

Mark Gallenberger, CFO

No, I think that's correct.

Mark Delaney, Analyst

That's helpful. Thank you for your comment there. For my second question, I wanted to better understand the growth in billings per car, which was very nice at 20% growth. You mentioned you changed the calculation about how you're coming up with that figure to be a little different. Would you be able to provide us with how that metric would have looked last quarter if you'd reported under this current methodology?

Mark Gallenberger, CFO

Yes, we can certainly do that. The only real difference is that last year we were using fiscal year-to-date versus the prior fiscal year. The reason we did that is we didn't have the specific data back in fiscal year '18, so we could only use fiscal year-to-date information. Now that we're well into the new fiscal year, we can use a trailing 12-month versus the prior trailing 12-month period. So yes, we can—last quarter was the same answer because it was the full fiscal year. So, we used fiscal year '20 versus fiscal year '19. The actual measurement or the result would be exactly the same as what we reported last quarter because it was trailing 12 months versus the prior year trailing 12 months.

Operator, Operator

Our next question comes from Chris McNally with Evercore. Your line is open.

Chris McNally, Analyst

Maybe if two questions. One to Mark on just the model and then Sanjay, we could talk a little bit about the long term. Mark, what we're trying to figure out is you used to have that great rule of thumb of 10% to 15% growth above production. It seems like with production moving around and a different growth rate in connected and professional that may not be the case anymore. Is there any way that we could think about any rule of thumb for the outgrowth going forward? Even if it's on an annual basis, just something rule of thumb because you're obviously going to grow a lot above, but it seems like it moves around year-to-year. So, I would love to get your thoughts on that.

Sanjay Dhawan, President and CEO

Yes. That's a tough one. It does move around. Last year, we had 28% or 28-point spread, so well above the 10% to 15%. It's almost like looking at trends, right? If you look at the last four or five years, we've been consistently above. We still think that's the case going forward because the penetration rates are not slowing. Last year, because we were so far above, it just makes this year a little bit tougher for comparisons, right? So we're probably a little under that spread, but still above what auto production will be doing, clearly still better than that. But maybe not quite as high as what we've seen historically. I think it's going to ebb and flow. A few factors come into play: prepays; we're planning to be lower this year. That will be reflected in that spread. Also, our legacy connected business, that's a flattening effect this year. That program is coming to an end, so we don't project any growth for fiscal year '21 for that business versus fiscal year '20, it should remain flat. So that has an impact as well. It's hard to give you a specific rule of thumb, as it's a combination of many factors that will ebb and flow. The underlying fundamentals of the secular tailwinds remain intact, and that’s where penetration rates are continuing for embedded and connected.

Chris McNally, Analyst

No, that makes sense. And I think going forward, we almost have to think about the license business as the only business that we can do a rule of thumb for, and we'll have to consider the year-over-year comparisons for the prepaid, so that makes sense. Sanjay, I know you're going to update later in the year on 2024. We're all looking forward to that as it seems things are moving in the right direction. Could we focus on the long-term aspect of the 2024 guide, that $75 million that you had indicated, examining these future drivers like Car Life and Cerence Pay? Can you talk about your confidence in that line item? Do we have enough visibility to book that much business out to 2024, or does the pipeline look very encouraging? Just curious how much visibility we have now versus when things need to unfold over the next couple of years.

Sanjay Dhawan, President and CEO

Yes. So in the last quarter, we booked two deals that will contribute revenue to that line; these are real bookings. We don't break them down from a number standpoint, but there are significant bookings. That was good; at least it started now. This current quarter, we have a strong pipeline, and I'm expecting more than two deals booked this current quarter that will contribute to that revenue line. We expect small revenues this year. We're assuming very little contribution from that this year. But as more cars ship with the apps and the new connected services, the revenue goes up. I'm feeling confident about the progress. Chris, it is hard work. We're working extremely hard and very focused to work with every OEM to bring these new capabilities in.

Operator, Operator

Our next question comes from David Kelley with Jefferies. Your line is open.

David Kelley, Analyst

Maybe just wanted to start with the Stellantis announcement. Can you give us a bit more color on the technology relationship there, and how you're thinking about the size of that incremental opportunity?

Sanjay Dhawan, President and CEO

Sure. Mark, I'll start and maybe you can jump in on the size and all that. The opportunity was basically with the official statement that we got clearance to mention just a few hours back was that Cerence has extended its partnership agreement to the next-generation cars of Stellantis. I'm reading it from the email from the accounts team. That's the official statement we are allowed to share at this stage. It's their next-gen platform. I can't go into the specifics because it's for them to announce. I'm honored and proud to be brought back in; this was one platform we had before Cerence was formed. When Cerence was still part of Nuance auto, we lost it to a competitor, and we're proud to be back in. Mark, we can't talk much about price, right?

Mark Gallenberger, CFO

Yes, unfortunately, we cannot get specific on any one particular customer unless we get their specific approval. At this point, we don't. With that said, though, it's a notable win, especially since we were brought back in.

David Kelley, Analyst

That's all fair. I thought I'd give it a shot. This may be switching gears to the Xevo announcement. You referenced the quicker bookings to revenue cycle. Can you provide, at a high level, how the revenue structure of that business works? I would assume it's more of a transaction basis. Just curious to get some color around that.

Mark Gallenberger, CFO

Yes, I can start, and Sanjay, if you want to fill in. It's like you said, it's a revenue-sharing or transaction-based approach, and it funnels through the Xevo platform. Our arrangement would be with Xevo, and they would manage those relationships, doing administrative work, etc. We would get a portion of our piece of it as those transactions occur in the market. It's a revenue-sharing type of arrangement based upon transactions, and we get paid from Xevo on that transaction.

Operator, Operator

Our next question comes from Jeff Van Rhee with Craig-Hallum. Your line is open.

Jeff Van Rhee, Analyst

Just outstanding execution here, really solid performance. A couple for me; I know you don't quantify bookings as it relates to bookings or do periodically. Can you give us some color, even quantitatively, about the bookings this quarter? Any observations about the size, scope, or other twists to what you booked or what you thought you'd book? And regarding the pipeline, what's the composition? Obviously, you have a lot of new products; I suspect you'll have some commentary about those new products starting to fill the pipeline. Any other observations regarding edge or connected—places where you're succeeding or lagging? A bit more color?

Sanjay Dhawan, President and CEO

Mark?

Mark Gallenberger, CFO

Yes. You're correct about bookings; we don't do it quarterly. We plan to give midyear and fiscal year-end updates on bookings and backlog. We're sticking to that because bookings can be lumpy from one quarter to the next, which we think is the right practice—do it once a year but twice a year. With that said, I think we'll defer our commentary on bookings until our next earnings call. However, pipeline remains strong as we continue to expand our product offerings and also into adjacent markets, naturally expanding opportunities in our pipeline. That's the color I can provide at this point.

Jeff Van Rhee, Analyst

Maybe win rates on connected deals. Can you comment on that?

Mark Gallenberger, CFO

Yes, I think the win rates are unchanged. We are not seeing any difference from what we've seen historically.

Jeff Van Rhee, Analyst

Fair enough. Then just last one on the PS side; a very good number there and a great leading indicator. From a utilization standpoint, where are you with respect to the capacity organization?

Mark Gallenberger, CFO

Sanjay, I don't have that number handy.

Sanjay Dhawan, President and CEO

Yes, we’re about running close to 80% utilization. We track utilization as billed to billable and billed to available. We're in our 80s. By the way, a few more percentage points can improve, right? The appointment of Sujal, our new PS Head, who comes from Harman's PS organization, understands this extremely well. The trick of improving gross margin has two aspects: number one, look at COGS and use as much offshore talent as possible for the right mix of offshore and onshore. The second aspect is improving utilization, which is what our focus is.

Jeff Van Rhee, Analyst

Okay. One last brief one, if I could; COVID. What are your assumptions now? You mentioned some cost return clearly when you come back to a more normalized environment. What magnitude of back in the office do you ultimately expect and any thoughts on timing?

Mark Gallenberger, CFO

Yes. We had some significant cost savings last year. We're starting to bring those expenses back in. In Q1, we were a little behind our hiring plan, which was part of the margin benefit. You'll see more incremental expenses coming back in Q2, about the same magnitude in Q3, then things will level off in Q4, probably still going up but not at the same rate. By the end of the fiscal year, I expect all those COVID savings to find their way back into the P&L along with the removal of the hiring freeze. We will have higher headcount relative to last year due to that. We also believe that some of the gross margin improvements in connected and pro services are sustainable. We'll be giving you an update on that long-term model in the coming months.

Sanjay Dhawan, President and CEO

Yes, Jeff, I just want to add that I'm extremely proud of our team's execution on profitability. You can compare us to many companies. Delivering 42% EBITDA this year and increasing guidance for the whole year; I'm very proud of our ability to deliver profitable growth, something that Mark and I believe in.

Operator, Operator

Our next question comes from Michael Filatov with Berenberg Capital Markets. Your line is open.

Michael Filatov, Analyst

Just one quick one, really. I believe your 2024 outlook wasn't baking in much in terms of renewals on the connected services side. Do you have better visibility into the expected renewal rates on the connected side and where those renewals stand today? When do both of those renewals start to happen?

Mark Gallenberger, CFO

Yes. You're right about our model. We were conservative, and we didn't factor in any renewals in our 2024 model because we just lacked data points. We still have that win that we announced last quarter; that’s the only update we’ve got. As we get more data points in the next year, we will gain more comfort regarding renewal rates. The consumer demand for connected cars is increasing, so the adoption rates we've seen in our slide deck should bode well for us in terms of renewals.

Sanjay Dhawan, President and CEO

Michael, just as a coincidence, I drive a 2017 BMW. This weekend I paid BMW $225 for a connected services package per year that provides connectivity in my car. I can share that transaction with you. If you go to connected drive.bmw.usa.com, you will see the packages that they have for various connected services, which I purchased.

Michael Filatov, Analyst

I appreciate that. That was great color. I know you provided some of the moving pieces around pro services revenue and some was pulled forward into Q1. Could you talk about growth expectations for new connected versus variable revenue and edge? What's really driving growth in your updated midpoint of your fiscal year guidance?

Mark Gallenberger, CFO

Yes. The new connected service, we see that continuing. Growth trends there continue to be good. In pro services, we had a strong prior year, up 55% year-over-year. Part of that was driven by acceleration of PS revenue into Q1. I would expect for Q2, PS revenues to down due to that, and that’s reflected in the guidance. Year-over-year, PS should be up as well. All fronts—license, connected, new connected business, and professional services—all of those businesses should be up year-over-year. All that’s factored into our guidance. We haven't gone granular on specific revenue streams, but at the corporate level, that’s how we build our total guidance for the year, being plus 12% to 15% year-over-year.

Operator, Operator

Our next question comes from Dan Ives with Wedbush Securities. Your line is open.

Strecker Backe, Analyst

This is Strecker on for Dan. With the recent GM headlines in electric vehicles and the massive EV push overall, can you, Sanjay, talk about how that plays into the Cerence growth story potentially over the next couple of years?

Sanjay Dhawan, President and CEO

Yes. We have announced many EV partnerships with GM over the last several quarters. Our core assumption is that cars are getting more digital, which means they're becoming more connected, electric, autonomous, and shared. User interaction using AI will play a more important role. It's our core thesis behind Cerence. As I showcased in my slides at Cerence in Motion, we focus on Driver AI, Cabin AI, and Road AI. This is our core focus because our core assumption is that cars are getting more digital, connected, and electric. AI's role in driver, cabin, and road interactions will increase. We aim to be a premier company focused on providing AI platforms for that growth.

Operator, Operator

There are no further questions. I'd like to turn the call back over to Rich Yerganian for any closing remarks.

Richard Yerganian, Vice President of Investor Relations

Thank you very much, and thank you for joining us on the call this morning. We hope to see you at one of our upcoming conferences over the next few weeks. Thank you, and have a good day.

Sanjay Dhawan, President and CEO

Thank you.

Operator, Operator

Ladies and gentlemen, this does conclude the conference. You may now disconnect. Everyone, have a great day.