Earnings Call
Cerence Inc. (CRNC)
Earnings Call Transcript - CRNC Q4 2023
Operator, Operator
Good day, and welcome to Cerence’s Q4 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this call may be recorded. I would now like to turn the call over to Rich Yerganian, Senior Vice President of Investor Relations. You may begin.
Rich Yerganian, Senior Vice President of Investor Relations
Thank you. Welcome to Cerence's fourth quarter and full fiscal year 2023 conference call. Before we begin, I would like to remind you that this call may involve certain forward-looking statements. Any statements that are not statements of historical fact, including statements related to our expectations, estimates, assumptions, strategy, goals, targets, and plans, should be considered forward-looking statements. Cerence makes no representations to update those statements after today. These statements are subject to risks and uncertainties that may cause actual results to differ materially from such statements, as described in our SEC filings, including the Form 8-K with the press release preceding today's call, and our Form 10-Q filed on August 8, 2023, and our most recent Form 10-K. 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 on definitions, limitations, and uses of those measures and reconciliations of non-GAAP measures to the closest GAAP equivalent. The press release is available in the IR section of the website. Joining me on today's call are Stefan Ortmanns, CEO of Cerence; Tom Beaudoin, CFO of Cerence; and Nils Schanz, our Chief Product Officer. As a reminder, the only authorized spokespeople for the company are Stefan, Tom, and me. Before handing the call over to Stefan, I would like to mention that we will be present at the Wells Fargo 7th Annual TMT Conference tomorrow, November 28; the UBS Industrial Summit on November 29; and the Raymond James TMT and Consumer Conference on December 5. Now onto the call.
Stefan Ortmanns, CEO
Thank you, Rich. Welcome, everyone, and thank you for joining us to discuss Cerence’s fourth quarter and full fiscal year results, guidance for fiscal 2024, and the update to our multi-year targets. Before I review the highlights of the fourth quarter and fiscal year, let me start by saying how excited I am about the future of Cerence. We remain well positioned to benefit from the execution of our strategy to build an immersive cabin experience, and these efforts are only enhanced by the rapid advancement and application of AI within our leading-edge solutions. We continue to build out innovative new capabilities based on advanced automotive-grade large language models and generative AI. We are already seeing a high level of interest and traction across our OEMs regarding these initiatives. We have had some incredibly strong additions to the leadership team over the last year. You met Iqbal Arshad on our last earnings call, who joined us in May as our Chief Technology Officer, and most recently, Christian Mentz joined our team from Amazon as our Chief Revenue Officer. Iqbal and Christian work in close collaboration with Nils Schanz, our Chief Product Officer. You will hear from him in a few minutes. We now have an extremely strong management team to guide the company forward, especially as generative AI and large language models accelerate transformation across transportation and beyond. No company is better positioned, prepared, or trusted than Cerence to guide and support automakers and mobility OEMs as they navigate the best path to providing their customers with an immersive, intuitive in-cabin experience. Building off our Destination Next strategy that we shared last year's Investor Day, we are deeply focused on leveraging our state-of-the-art AI technology in two ways. First, enhancing our current software platform with products that enable OEMs to quickly, easily, and cost-effectively deploy new AI-driven applications to their drivers via over-the-air updates. And second, by creating a unique user experience with cutting-edge, automotive-certified large language models. You will hear more from Nils on that in a moment. Due to the significant shift in our industry, we see further opportunities to position ourselves for growth. Therefore, we have slightly pivoted our strategy over the short term to capitalize on these exciting industry trends. While this opportunistic evolution of our strategy had an impact on targeted revenue for some of the outer years in our multi-year plan, our long-term performance targets remain unchanged. We believe that our focus moving forward will help us to accelerate the realization of our vision and to deliver on our performance targets of achieving double-digit revenue growth and approximately 30% adjusted EBITDA margins starting in fiscal 2026. With that, I would like to point out some of the highlights from Q4 and the full fiscal year. In Q4, we delivered solid results with revenue of approximately $81 million, well above the high end of our guidance. Our core auto business delivered strong results, with our global auto penetration staying strong at 54% on a trailing 12-month basis, which is a testament to our significant value add. Our innovation and strong capabilities continue to translate into significant new business. We secured several strategic wins during the quarter, including three in automotive and another in the two-wheeler space. One of the automotive wins was to support the global expansion of a major Chinese OEM, a continuing trend that we have benefited from, given the extensive language needs required as OEMs enter new markets. You may recall that on our Q3 conference call, our CTO, Iqbal Arshad, shared with you our strategy for incorporating the latest developments in generative AI and large language models into our current product offerings. This has been extremely well received by our customers, leading us to deliver more than 15 proof-of-concept programs globally during Q4. On today's call, Nils, our Chief Product Officer, will provide some insight into how innovation in our current product lineup is expected to serve as the foundation for our future product vision and strategy. We have already shared our plans with select customers, and I'm very excited about the extremely promising feedback. I hope you will be able to visit our booth at CES to witness the new products in action. Moving on to review the full fiscal year, I'm very pleased to say that we delivered on our commitments for FY 2023, including revenue and all key profitability metrics we provided last November. Importantly, we remain committed to a strong focus on operational excellence. In FY 2023, we had 14 strategic wins. These wins came from across the globe and included five competitive win-backs from both niche and consumer tech competitors. Our core product Cerence Assistant had nine design wins during the year, including the first win for a Chinese OEM's domestic program. For one of these customers, we were able to achieve start of production in just four months. Overall, we hit the start of production for more than 17 platforms that utilize our latest solutions. We also continue to make good progress in adjacent transportation markets, winning two more two-wheeler customers during the year for a total of nine, including some of the most recognizable names in the market. It's important to note that we have won every two-wheeler opportunity that we have pitched against both small and consumer tech competitors. We had our first start of production with five previously won two-wheeler customers and expect those revenues to begin ramping in fiscal year 2024. We have also started to build a pipeline for our non-transportation business, also known as AIoT, with six design wins, two in North America and four in Asia-Pacific. You may recall, we are currently limited in what technologies we can market outside of transportation because of the field of use restriction we have with Nuance, now Microsoft. We are in the last year of this agreement, and come next October, we will be able to freely take our scalable AI technology stack to any market where we think we can provide value. As we previously discussed, we entered FY 2023 knowing that from a revenue and profitability perspective, it was going to be a transition year. Overall, as a team, we are very pleased with our progress. And as we look forward, we are very excited about our expected near and long-term future success. Before Tom reviews the financial details of our performance, we wanted to share how we are approaching the market from a product perspective, especially in light of the market dynamics and demand for AI-driven solutions. At its core, there are three pillars that are key to our strategy. The first is providing our customers with a tailor-made solution. Second, the immersive in-cabin experience will continue to grow in importance in the buying decision of the consumer. Therefore, creating a unique branded experience is a key focus for our OEMs. The third pillar is advancing natural human-like interaction. People will use a system if it is easy, intuitive, and responsive. Our deep vertical expertise in the automotive industry and extensive set of data in combination with large language models and generative AI technologies are the cornerstones of our OEM-branded offering. With that, I'm pleased to turn it over to Nils Schanz, our Chief Product Officer and former Head of User Experience for Mercedes, to share a bit more about our product plans and technology vision. Nils, please.
Nils Schanz, Chief Product Officer
Thank you, Stefan. The recent advancements in generative AI and large language models have opened up a whole new world of opportunity. Cerence has a distinct role to play in the application of these technologies, using our unique deep understanding of automotive and transportation-specific requirements and dynamics to ensure added value for the end user. We are incorporating the extensive vertical expertise we have in the automotive industry and combining it with the latest innovations in AI through a two-step approach. First, by enhancing existing products, and second, by creating an entirely new architecture that we believe will result in a completely unique solution for the industry, capable of delivering groundbreaking user experiences. Our path forward is defined by a product roadmap based on a multilayer generative AI strategy. There are several key considerations guiding this strategy. First, focus on automotive-specific tasks and applications via fine-tuned large language models (LLMs). Second, deliver an optimal balance of user experience, cost, and performance through a thoughtful combination of third-party LLMs, Cerence’s proprietary LLMs, and traditional AI models. And third, provide transparency and full control over the user experience so OEMs can safely, accurately, and reliably serve their customers. We have upgraded our product portfolio with LLM technologies, developing new products and integrating them with our first customers. Cerence Car Knowledge leverages AI to transform the intimidating 500-page manual that usually sits in your glove compartment into user-friendly, voice-activated information. Our solution provides information retrieval in real-time, contextual information based on trustworthy OEM data, and information specified down to the model and even the VIN. Car Knowledge can be leveraged via voice through the in-car assistant or on a companion app or even in social media or any web application. Cerence Assistant with NLU Plus brings the power of LLMs to our turnkey hybrid solution. This next generation version of Cerence Assistant is optimized to provide users with more natural, intuitive, and accurate interactions while minimizing cost. Cerence Assistant now easily handles complex queries and multi-step tasks within a single request. Cerence ChatPro expands the Assistant's ability to answer general interest questions. It is a predefined and flexible Q&A solution that includes no-code infrastructure for customization that enables OEMs to create brand personality. Cerence ChatPro leverages a multitude of sources including ChatGPT to provide accurate and relevant responses to nearly every query imaginable. These free cloud-based products can be quickly deployed as upgrades to existing platforms already in production, delivering added value to drivers and supporting our strategy to increase connected services growth. In fact, one of our customers is going live in calendar quarter one. It's important to note that these products can also be applied to our strategic adjacent markets, two-wheelers and trucks. We also see use cases for non-transportation applications. For example, using our Car Knowledge product for appliances or industrial IoT. The same concept of building an intelligent blueprint to the device that can be accessed by the user at any time still applies. As for where we are heading in the future, we are uniquely positioned to capitalize on the prevalence of generative AI and LLMs. Our product roadmap is fully focused on developing generative AI-powered products based on an automotive-grade large language model, the first in the industry. Our R&D and product teams are currently building this automotive-grade LLM, which will be presented at CES in collaboration with a major European OEM and is based on our unmatched automotive data set. Unlike others who have simply plugged ChatGPT into an existing system, we know that in order for OEMs to maintain their branded experience and for end users to gain value from the integration, a more thoughtful approach is needed. The limitations of the technology need to be acknowledged and addressed. A serious issue is the lack of response reliability. Responses can sound highly plausible yet be completely incorrect, otherwise known as hallucinations. Responses can be self-contradicting, non-transparent, or offer unreliable data source attribution. We address this by fine-tuning large language models on curated data sources. For example, Car Knowledge uses accurate OEM data for precise information. The large size of LLMs results in high operating costs due to substantial computational power needed. Public LLMs may not be cost-effective for certain tasks compared to traditional search or natural language understanding-based chats. Our approach to this issue is to apply a mixed strategy using third-party and proprietary LLMs, improving cost-effectiveness and control. We leverage LLMs to support the development of smaller deep learning models, improving cost and time to market. Another concern is that the system's response time can be slow due to the latency of LLMs, which is not within the user or OEMs' control. The Cerence approach is a seamless integration of deep learning models of various types and sizes, optimized for specific use cases. We optimize efficiency, reliability, and scope across all Cerence domains, ensuring latency remains within our benchmarks. Another challenge is that constant cloud access in cars isn't guaranteed, making embedded solutions crucial. Performance and cost optimization will be key for embedded applications of LLMs and generative AI. To address this, we are focused on developing optimized LLMs for use on embedded platforms, leveraging our automotive and embedded expertise as a competitive advantage. So what sets Cerence apart from the competition as the essential innovation partner when it comes to generative AI and LLMs? We have the unique expertise to leverage these technologies with a specific lens for automotive and transportation user experiences, prioritizing safety and producing up-to-date, correct, and trusted information. Generative AI and LLMs are among Cerence's core competencies. We have been applying deep neural network-based AI technology, including generative AI, to our products for years. In addition, the Cerence technology stack implements AI on both the cloud and edge. We leverage OEM and Cerence data to make sure every end user always gets the most accurate response. Finally, we can decide whether a command is best processed by our conventional AI stack, our LLM technology, or by an external LLM service, ensuring full functionality at minimum cost. The engineering and product teams here at Cerence are well aligned. We are excited about how the right application of generative AI and LLM technologies will transform the user experience in the car and the central role we can play in making that happen. I will now turn it over to Stefan for a few comments on fiscal year 2024 priorities, before Tom goes into the financial details of the year and our multi-year targets.
Stefan Ortmanns, CEO
Thanks, Nils for sharing Cerence's AI Product Strategy. Looking ahead to fiscal year 2024, we have a series of key objectives for the company. First and foremost is to delight our customers. We do this by delivering high value-added customer-driven solutions on time and with exceptional quality. Under the leadership of Nils, we have made great progress and expect that to continue into the future. From an R&D perspective, it's absolutely critical that we continue to innovate and make strategic investments in our technology by architecting a software platform that incorporates the latest advances in generative AI and large language models. We have the unique opportunity to capitalize on our vertical software expertise and extensive OEM-specific datasets. We are in the process of transforming our strategy into real solutions, driving growth in connected services billings. We will preview these solutions at CES and expect to deliver to customers in calendar year 2024. We also expect to make additional progress in the adjacent transportation market and beyond. And of course, we will continue to have a strong focus on operational excellence allowing us to potentially meet or exceed our financial goals for the year. With that, I would like to hand the call over to Tom. Tom?
Tom Beaudoin, CFO
Thank you, Stefan. When I joined Stefan's leadership team about 1.5 years ago, we set a goal to meet and, if possible, exceed our financial guidance to investors. The fourth quarter of fiscal 2023 marked our fifth consecutive quarter of achieving this goal. With the exciting opportunities ahead of us, we anticipate positive momentum continuing into fiscal year 2024. In a moment, I'll provide guidance for Q1 FY 2024 and the full year, followed by our multi-year targets. First, I want to highlight our strong performance in FY 2023, particularly in Q4. Our Q4 results demonstrated ongoing business momentum with robust revenue, margins, adjusted EBITDA, and cash flow from operations. Q4 revenue was nearly $5 million above our guidance's high end, primarily due to a one-time true-up with a customer. It's not uncommon for customers to occasionally update their royalty reporting with adjustments. Importantly, even without this true-up, our revenue would still have exceeded our guidance's high end. Q4 revenue included a fixed contract of $12.8 million as mentioned in our Q3 call, with strong results driven by our core transportation business. The combination of revenue exceeding our expectations and our emphasis on operational excellence allowed us to surpass key financial metrics for adjusted EBITDA and cash flow from operations. Our non-GAAP gross margin was 72.9%, and our non-GAAP operating margin was 17.8%. Adjusted EBITDA came in at $16.6 million, representing a 20.7% margin, with non-GAAP income per share at $0.09. We achieved positive cash flow, with cash flow from operations around $11.3 million. Our balance sheet remains strong, with total cash and marketable securities of approximately $121 million. Looking back at the guidance we provided last November, we exceeded every financial metric, both GAAP and non-GAAP. Revenue was $294 million, which is $4 million above the high end of our range, despite fixed contracts for the year totaling $36.5 million, about $3.5 million lower than anticipated. Our revenue breakdown for the quarter shows strong core drivers. Variable license revenue increased by 59% year-over-year and 17% quarter-over-quarter, influenced by lower fixed contract consumption and a one-time true-up. Our penetration of global auto production stood at 54% over the trailing 12 months, reflecting a solid market position. New Connected Services revenue rose by 13% year-over-year and 6% from the prior quarter, and we expect this segment to ramp up in FY 2024 as key programs delayed by customers enter production. We have a strong pipeline for connected services. While professional services revenue dipped by 12% year-over-year, it increased by 8% quarter-over-quarter. As previously noted, professional services will fluctuate based on customer project timelines and are not expected to drive revenue growth but will support future license and connected revenue. Our newer products and solutions have enhanced features that reduce reliance on professional services. In terms of our licensing business, the overall picture remains strong, with pro forma royalties rising by 10% year-over-year and 3% quarter-over-quarter due to increased auto production and our technology's growing penetration. Pro forma royalties reflect the value of variable licenses shipped during the quarter. We continue to manage the share of fixed contracts down. With the fixed contract signed in Q4, we ended the year with $36.5 million in total fixed contracts, below our maximum commitment of $40 million. Consumption in fiscal 2023 fell from the previous year, and we expect further improvement in FY 2024. After discussions with our sales leaders, we will reduce the maximum annual fixed contracts from $40 million to about $20 million starting in FY 2024. This change should allow us to maintain flexibility for a small number of clients while transitioning away from such contracts. We anticipate a decline in fixed contract consumption over the coming years, which will aid in increasing our non-fixed contracts. As this shift happens, we expect to gain better clarity and insight into our revenue trends, which we view positively. We estimate our fixed contract balance at the end of fiscal 2024 will be around $40 million, down from approximately $80 million at the end of fiscal 2023, with a normalization expected by the end of fiscal year 2025. Our KPIs continue to reflect strength in our business. Our penetration of global auto production rose to 54% over the trailing 12 months, indicating more than half of global auto production incorporates some level of our technology. In the quarter, we shipped 11.7 million cars with our technology, a 4% year-over-year increase, which outperformed macro trends and reflects an improving production landscape as well as our solid competitive position. Cars using our connected services rose by 16% year-over-year, showcasing the trend towards greater connectivity and our ability to offer innovative solutions. For FY 2023, total billings grew by 6% compared to the previous year, excluding professional services and prepaid contracts, providing insight into our core business trends. Therefore, we are now opting to report total adjusted billings growth on a trailing 12-month basis. We will no longer provide a billings per car metric, as it can be influenced by multiple factors. We are pleased with the 6% year-over-year growth in total adjusted billings, which we believe is a strong signal for future revenue growth. We also decided to substitute the average contract period KPI with growth in deferred revenue, which we believe offers a more dependable look into our potential revenue prospects. Additionally, we experienced a 30% year-over-year rise in monthly active users, reflecting growing interest in our technology. During this quarter, we learned that our legacy connected services customer, Toyota, will terminate their service effective December 31, 2023. Before this decision, we would have recorded revenue of about $8.4 million per quarter under this contract through Q1 fiscal 2026. This contract was amortized from a connected services program acquired by Nuance in 2013, with the majority of cash collected prior to our spinoff. The effect of this change is to accelerate any deferred revenue linked to this contract into Q1 of fiscal 2024. We’ve provided detailed revenue impacts by period through 2026 for clarity. Thus, our guidance for Q1 includes around $73.6 million in revenue from this change. After Q1, we will not have any legacy revenue to report, resulting in a clearer business outlook. Moving to revenue guidance for Q1 and the fiscal year: as previously mentioned, we will manage fixed contracts down to a maximum of $20 million per year starting in FY 2024. Given this, we don’t expect any fixed contracts in Q1. Our best estimate would spread the $20 million relatively evenly throughout the fiscal year, with the understanding that actual execution can fluctuate quarter-to-quarter. Considering the impacts from the termination of legacy services and the reduced fixed contracts, we are guiding Q1 revenue to be between $132 million and $136 million. For the full fiscal year, we expect revenue between $355 million and $375 million. Note that without these adjustments and with the anticipated consumption of two fiscal 2023 fixed contracts factored in, our guidance would range from $340 million to $360 million. The revenue guidance and related financial metrics are illustrated on this slide. A few considerations are important as we reflect on our multi-year targets. First, we remain dedicated to delivering double-digit revenue growth and approximately 30% adjusted EBITDA margins in the midterm. With the legacy contract ending after Q1, we foresee better adjusted EBITDA to cash flow from operations performance since the legacy contract did not produce cash flow. Furthermore, with the anticipated growth in connected services, we expect cash generation to improve as billings during the subscription period occur upfront and revenue is amortized thereafter. Although growth in new connected services revenue may slightly lag due to this amortization effect, the anticipated rise in billings should drive significant increases in cash flow and deferred revenue. Additionally, the reduction in fixed contracts from $40 million to $20 million is expected to result in two benefits: first, fewer fixed contracts mean no additional discounts off the contracted price; second, a reduction in fixed contracts will lower current inventory consumption, thus increasing our variable revenue reported quarterly. Since our Investor Day last November, generative AI and large language models have gained prominence in our innovation strategy, enhancing our vision for an immersive cabin experience. While these technologies are not new to Cerence, we see significant potential to enhance user experiences through the application of these advancements. Consequently, we are shifting our investment strategy to focus on creating a leading software platform that integrates the latest in generative AI, rather than concentrating solely on organic software developments in the automotive sector. We will now seek partnerships for adjacent opportunities, focusing on our strong capabilities and trends within AI. With that insight and expectations of low-single-digit production growth as forecasted by IHS, I’ll provide more details regarding our plans. We continuously explore ways to enhance insights into the drivers of our core business. A project initiated last fiscal year aimed to support semi-annual reporting of five-year backlogs, improving our understanding of revenue cycles. Our insights, combined with evolving strategies, have led to updated multi-year revenue targets, particularly for FY 2026 and beyond. Moving forward, we will no longer report bookings—only five-year backlog reports semi-annually. Total bookings for fiscal 2023 amounted to $455 million. We believe five-year backlog, along with auto licensing and connected revenue visibility, are more reliable indicators of growth in the short, medium, and long term than fluctuating total bookings. Therefore, we will provide five-year backlog statistics semi-annually from now on. Overall, our five-year backlog has grown by around $140 million, a 13% increase from the end of fiscal 2022, reaching $1.2 billion. License revenue backlog rose by 31%, while connected backlog grew by 5%, largely influenced by the legacy contract. Professional services backlog declined by $2 million or 2%. We expect professional services to remain flat or decrease, as they enable our licenses and connected services without being a primary growth driver. Notably, our backlog offers better insight into the company’s long-term growth. The current visibility we have about future business is illustrated through various stages of expected backlog contributions. "In production" refers to active programs generating revenue, driven primarily by auto production levels. "Pending SOP" denotes programs under contract still in development, anticipated to start production within the year. Additional contributions from new contracts will also be needed to support revenue growth. The table on the right offers visibility into our new connected services. The expected revenue contributions from backlog for each year are shown at the bottom, indicating high visibility into anticipated revenues—approximately 88% to 93% in 2024 and 79% to 84% in 2025. As expected, the current fiscal year we’re guiding for provides higher percentage visibility than subsequent years; nonetheless, the nature of our business provides good revenue clarity, due to the typical four to five-year lifecycle of new infotainment programs. The percentage of revenue categorized as repeatable—defined as product revenue excluding fixed contracts and professional services—remains high, expected at 76% in FY 2024 and growing to 77% by FY 2027. This reinforces our confidence in our revenue generation capacity and quality revenue stream. We anticipate strong growth in our connected services, where revenue amortization over the subscription timeframe may delay revenue growth in relation to increased billings and deferred revenue. The chart illustrates the expected trajectory of our connected services business, excluding deferred revenue associated with the Toyota legacy contract. It shows the promising growth in connected billings, leading to cash generation, followed by a rise in deferred revenue. Furthermore, we note the compounding effect of cars on the road using our connected services each year. In conclusion, this table summarizes our updated multi-year targets, reiterating our midterm objectives of double-digit revenue growth and around 30% adjusted EBITDA margins. There is also significant anticipated growth in cash flow from operations if we meet these targets. We’ve enhanced detail and disclosures to provide insight into our business and the factors supporting our belief in strong future performance. It's essential to note the changes factored into these targets. Revenue consumption shifted from FY 2023 to FY 2024 due to timing on two FY 2023 prepaid deals. Revenue reductions have been noted for FY 2025 and FY 2026 due to the accelerated recognition of Toyota's deferred revenue, resulting from their earlier-than-anticipated decommissioning of their solution. The total revenue line at the top reflects expected reported revenue, while the subsequent lines exclude any Toyota legacy revenue for clarity. We also adjusted for the drop in fixed contracts, reducing from $40 million to $20 million starting in FY 2024. Moving forward, only prepaid fixed contracts will be offered. The revenue figures presented account for our strategic shift away from non-core automotive technology pursuits better suited for partnerships. We see an exciting chance to leverage our capabilities in light of favorable AI trends. I urge you to visit our booth at CES this January to learn more about the innovative developments Iqbal and Nils are working on for our customers, and the preliminary feedback has been very positive. Lastly, our initiative to report five-year backlog semi-annually has prompted deeper analysis of revenue from active and impending deals, enhancing our understanding of the necessary new contracts and revenue cycles within our targeted timeframes. The results of this analysis are evident in the data presented. In summary, we're genuinely enthusiastic about Cerence's direction under the current leadership team. We believe our investments in cutting-edge technologies will reinforce our position as the leader in AI-enhanced immersive cabin experiences in transportation. That concludes my prepared remarks, and now we will open the call for questions.
Operator, Operator
Thank you. Our first question comes from Luke Junk with Baird. Your line is open.
Luke Junk, Analyst
Good morning. Thanks for taking the questions. For starters, just hoping you can help build us the bridge from prior fiscal 2024 indication to what you're formally guiding for fiscal 2024 now. I think some pieces of this are pretty straightforward in terms of the Legacy contract piece plus the reduced target for fixed contracts. Maybe if you can just focus on the other moving parts in the core that we're seeing in the updated numbers?
Tom Beaudoin, CFO
Rich, do you want to take that?
Rich Yerganian, Senior Vice President of Investor Relations
Sure. So if you look at fiscal 2024, again, the guidance was $355 million to $375 million. The consumption shift, if you remember, we talked about how there was the two fixed contracts in fiscal year 2023, the one in Q1 that had an eight-quarter consumption period, and the one in Q4 had a four-quarter consumption period, which differs from our six-quarter consumption model that was going to push about $10 million of consumption into fiscal 2024. So that's one factor. The second factor is the reduction of $20 million of fixed contracts from the $40 million down to $20 million. So when we originally provided the target for '24, it was using a $40 million prepay or fixed contract, now that's $20 million. And then the adjustment for the third piece is the adjustment for the total. So again, those are the three pieces that if you take the guidance that we gave today, which was $355 million to $375 million for fiscal '24, would have been, if those factors weren't in play, $340 million to $360 million.
Luke Junk, Analyst
Got it. And then, thanks for that, Rich. Bigger picture question, just you mentioned the proof-of-concept programs that you have going on right now with generative AI and large language models. Just wondering how close we should think to bookings those programs are, or just said differently, as you make this pivot how you're measuring yourself relative to customer reception and ultimately getting bookings on this new software platform?
Stefan Ortmanns, CEO
Hey. Good morning Luke. It's Stefan here. Let me take it first, and then I will hand it over to Nils. So what we discussed also over the last couple of quarters is that we have created now a software platform. It's highly differentiated in AI. It's going far beyond natural language understanding, and also we have integrated generative AI with large language models in combination with automotive data that we have access to all of the sensitive in-car data. And also advancing the complete solution, called the Cerence Assistant platform with proactive AI. As I mentioned also, we had last quarter, 15 proof-of-concept programs across the globe, North America, Europe, China, Asia-Pacific in general. The feedback is very, very good and also, as Nils mentioned in his note earlier, you will see also a big announcement at CES with one of the largest carmakers. We're moving in this direction, and our bookings over the next couple of months will come for sure.
Nils Schanz, Chief Product Officer
That's maybe just one you have well summarized, but what I would add is that basically with the products I introduced to you, we can upgrade really existing platforms in the field. So we do this via cloud updates only, or in some cases also via over-the-air updates. And this allows us basically to go live here and deploy these programs or deploy these products in the next weeks. And as mentioned, we will go live in calendar quarter one with first customers here.
Luke Junk, Analyst
And if I can just sneak one more in, in terms of the midterm indication, maybe a question for Tom, just how we should think about R&D at a high level, as you pivot away from adjacencies in the car to AI and large language models and what a partnership in that respect might look like as well?
Tom Beaudoin, CFO
Yeah. Sure, Luke. So we continue to invest heavily in R&D. We assess that every year with Iqbal and the team. We drive some efficiencies and savings, and then we reinvest that. I think if you look at some of our midterm targets of where we're trying to hit the 30% plus EBITDA. I think R&D will continue to be relatively consistent with a little bit of leverage from a percent of revenue standpoint. But as we've talked about previously, sales and marketing and G&A, I think we have a fair amount of leverage in those two areas. And we will continue to generate strong gross margins through the licensing Connected Services business.
Stefan Ortmanns, CEO
And one additional comment, the beauty of our new software-based platform is that we can also utilize our data and platform for non-transportation segments.
Luke Junk, Analyst
Go ahead, I'll leave it there. Thank you.
Rich Yerganian, Senior Vice President of Investor Relations
Thank you.
Operator, Operator
Thank you. Our next question comes from Colin Langan with Wells Fargo. Your line is open.
Colin Langan, Analyst
Great. Thanks for taking my questions. Just to follow up on the first question, if we look at the adjusted guidance of $340 million to $360 million excess special items, it would still be below the $385 million, sort of, I guess you called it a target at the Investor Day last year. And then if I go out to '26, the midpoint of your sort of target for '26 is now $375 million versus last year was $515 million so substantially lower. What is driving that sort of near-term, long-term, lower outlook? Yeah, what is the key there?
Stefan Ortmanns, CEO
Maybe let me tackle it first, Tom, and then you will comment on the words. So we have made a strategic move compared to last year's Investor Day where we said, okay, we are focused on also on other organic opportunities. We strongly believe focusing on generative AI and large language models will have a higher return on investment in the future. For FY 2024, we have picked in the opportunities with respect to generative AI, but not in the outer years. Then we have the Toyota case and then also what Rich mentioned, we have reduced also the prepayments from $40 million to $20 million for the upcoming years. Tom, please.
Tom Beaudoin, CFO
Yeah, Stefan, I think you covered it well. So I think it really is those three drivers, right? A refocus and really alignment to our opportunities that we feel, as Nils talked about, and Stefan, and therefore, a little bit lower revenues from some of those adjacency technologies that we think are better served through partnerships. And then, of course, the effect of the legacy pull-in and what we think is the right thing for the business, which is the lower prepaid amounts.
Colin Langan, Analyst
And any examples of what you're not targeting now for the market opportunities that you're sort of letting go to out to partners, I guess?
Stefan Ortmanns, CEO
Well, I think if you remember in the investor presentation there were some adjacent activities in supplying some data and information that's our core to the three product strategies that Nils laid out and I think we're just refocusing our investments on the core. Is there anything you can add to that, Nils?
Nils Schanz, Chief Product Officer
No, exactly. I mean, we have presented back in the time a couple of initiatives, right, that we wanted to expand, for instance, in the biometrics field, and there we have shifted now some of these programs more to the LLM-based architecture and really upgrading our portfolio with generative AI. That is the full focus.
Colin Langan, Analyst
Got it. And just lastly, with the new change on fixed contracts down to $20 million, when should we think of that sort of consumption versus revenue stabilizing? Is that now like a 2026 timeframe where those kind of even out?
Nils Schanz, Chief Product Officer
Colin, that's correct.
Colin Langan, Analyst
Okay. All right. Thanks for taking the questions.
Operator, Operator
Thank you. Our next question comes from Quinn Bolton with Needham. Your line is open.
Quinn Bolton, Analyst
Hey, guys. Thanks for letting me ask a question. First, I just wanted to clarify the decline in the connected backlog. Is that due entirely to the Toyota legacy coming out of that figure?
Stefan Ortmanns, CEO
Yeah. That's mostly. As you can see from some of the other metrics that we provided, the connected services across the billings have been growing quite well, even the new connected services have been growing in the last few quarters. And then as we stated, I think if you look at our deferred revenue, historically and on a go-forward basis, it's the kind of best indicator of the future revenue growth, which lags a little bit due to the amortization schedule. But Connected Services, I think, is performing quite well, and we think it's going to be a big growth driver going forward.
Quinn Bolton, Analyst
Got it. And the second question I had is, I think last quarter you talked about the push out of some of the SOPs delaying some of the higher-priced offerings, kind of wondering. You've mentioned a couple of times connected services is seeing a delayed effect because of the amortization. I mean, can you give us sort of your outlook just how you're looking at pricing per vehicle as you move into fiscal 2024 and perhaps beyond?
Stefan Ortmanns, CEO
Yeah. Okay. Go ahead. Tom, please go ahead.
Tom Beaudoin, CFO
We are seeing positive growth in pricing per unit across the board. Some of the delayed standard operating procedures have been incorporated into our 2024 guidance and the revised multi-year plan. Overall, this reflects an average across our high engagement with all original equipment manufacturers. Some of these manufacturers start with only a few of our solutions at a lower price point per unit. This is part of the reason we believe that focusing on total billings growth is a more effective measure of our status as the preferred supplier in the market, indicating the growth in billings and revenue that will arise from this. The products mentioned by Nils all maintain a relatively high pricing per unit.
Stefan Ortmanns, CEO
Yeah. So maybe what we can say here is actually three factors. So first of all, we have high visibility into our OEMs' start of production, right? Special thanks also to Nils, because he's also driving professional services across the globe. Secondly, for new programs, we see, indeed, a higher pricing per unit across embedded and cloud. And thirdly, what Nils also mentioned is now we have opportunities for upselling, meaning bringing new innovations on SOP cars, meaning cars on the road.
Quinn Bolton, Analyst
Yeah. And that was giving my sort of second or perhaps third question was just, you talked a lot about the new software offerings around LLMs and generative AI, the first of which goes into production in the calendar first quarter. Can you talk, how does that affect pricing per unit? I would assume that that probably comes in at a pretty good pricing per unit as you deliver those software, but wondering if you might be able to provide sort of any additional color on how you're thinking about pricing the new AI and LLM offerings. Thank you.
Stefan Ortmanns, CEO
We cannot share everything here for sure. But you will see a big announcement during CES with one of the largest car makers worldwide. We are addressing already SOP cars but also new programs with our new LLM-based architecture. Nils, additional comments from your side?
Nils Schanz, Chief Product Officer
No exactly, as you said, we will not share pricing details here, but basically we see a lot of demand from all our OEMs, from all our customers supporting them with exactly the products I presented. So it's really about not just plugging in ChatGPT. We clearly hear from customers that this is not sufficient; instead, they need our infrastructure and our layer in between to support them managing the cost, ensuring best performance, and really provide safe and reliable information which they provide to the end user.
Quinn Bolton, Analyst
Got it. Thank you.
Operator, Operator
Thank you. Our next question comes from Mark Delaney with Goldman Sachs. Your line is open.
Mark Delaney, Analyst
Yes. Good morning, and thanks for taking my questions. First, I was hoping to better understand the dynamics of Toyota. Is Cerence still selling to Toyota just under a different program going forward, or will they not be a meaningful customer after fiscal Q1 with the acceleration of the deferred revenue?
Stefan Ortmanns, CEO
Yeah. So we have the preferred partner of Toyota, Toyota North America, Toyota Europe, and Toyota Japan, the mother company. As a reminder, the program what Tom referred to goes back to 2011. I mean, compared now to the new technologies or applications in the car, it was clearly not competitive and there was also low traffic after almost 12, 13 years, and they came to this decision, right? So but still, we are working with Toyota on model year 2024 and other opportunities.
Mark Delaney, Analyst
Okay. And so the new multi-year outlook would assume perhaps maybe sales under these newer contract types, and perhaps maybe even some higher, I mean, would you ship in more under the newer programs if they're shifting there from this?
Stefan Ortmanns, CEO
It's always the newer programs, right, based on Cerence Assistant with all the latest and greatest technology.
Mark Delaney, Analyst
Okay. My other question was just on the consumption of fixed contracts. Tom, you mentioned it's slowing down, and I think guidance for this coming fiscal year applies maybe $60 million of consumption. So it's maybe it's been understood that the reason that the consumption of the licenses is starting to decline?
Tom Beaudoin, CFO
Yeah. Well, it's a combination of the decision we made starting in Q4 of 2022. We didn't do any fixed contracts, and then this year we limited it to $40 million. And then on a go-forward basis starting this year, to $20 million. So we're adding a lot less to be consumed in the future, and then we're burning off the higher levels back in, kind of, '21 and '22 from both fixed contracts and the minimum commitments deals. And just to remind you, we're not doing any further minimum commitment deals.
Mark Delaney, Analyst
Understood. I'll turn it over.
Operator, Operator
Thank you. Our next question comes from Jeff Van Rhee with Craig Hallam. Your line is open.
Jeff Van Rhee, Analyst
Great. Thanks for taking the questions. Maybe a couple for Nils, if I could start with you. On the LLMs, it sounds like you're obviously going with a hybrid architecture. You can expand a little bit further on what are some examples of cost-effective versus non-cost-effective, where you might use external versus not?
Nils Schanz, Chief Product Officer
Yeah. Sure. So basically, what we are trying to do is really keeping the model parameters optimal. So we really fine-tune the applications to the needs of the OEMs. And then you should know that, let's say, the context window in automotive is a bit smaller, which allows us to really manage the cost and have only a viable cost structure. On your point of cloud and in-car systems embedded, so we clearly see that still the solutions the OEMs ask us for should also cover embedded, so that's clearly the need, and there we can support with our new solution where we fine-tune based on our automotive-specific data and customize it to the auto use cases for the OEM. So basically, what it means is that we can decide together with the OEM which queries are forwarded to a third-party LLM and which can be covered by our conventional AI stack or our proprietary LLM we have built.
Jeff Van Rhee, Analyst
Okay. Tom, did you break out the EBITDA impact of Toyota for Q1?
Tom Beaudoin, CFO
No, but it's a very small deferred revenue component to it. So most of that whole amount of revenue is profit.
Jeff Van Rhee, Analyst
Yeah. Got it. Fair enough. And then maybe lastly on connected, just curious what process improvements you've made with respect to gathering, analyzing, incorporating your learnings from usage on connected. Obviously, you get some very valuable data. I think you had some efforts to try to improve the ability to capture that and gain insights. Just what might have changed there?
Stefan Ortmanns, CEO
May I just for clarity, Jeff, on the technology side?
Jeff Van Rhee, Analyst
No, from process-wise. So you get the insights on usage. In the past, I've asked a lot of questions about what features, functions, capabilities are really getting consumed. It sounds like there were a lot of steps and initiatives internally to get more precise and understand exactly what people want and were using. Curious if those initiatives have been implemented and what kind of insights you have on connected usage.
Stefan Ortmanns, CEO
So what we see here, Jeff, is the following. So when comparing year-over-year, we see a year-over-year growth of about 16%. When looking at monthly active user, it's up by 30% or even more year-over-year, right? This shows actually that our solution is adopted by OEM customers and finally also our customers. Nils and the team are looking together with the OEMs how to improve further adoption here; that's key to success. We have also this platform where we can also adapt and adjust the specifics and also create more personalized information for the drivers and passengers. Overall, we are making great progress and we are also related as we are the innovation partner of most of the OEMs, right, in close collaboration with the OEMs.
Jeff Van Rhee, Analyst
Okay. Great. Thank you.
Operator, Operator
Thank you. Our next question comes from Chris McNally with Evercore ISI. Your line is open.
Chris McNally, Analyst
Thanks so much, team. I appreciate all the numbers. So, I wanted to step back and follow up a little bit on Colin's question and if we understand pulling out the transportation adjacencies and non-transportation. We looked at the old multi-year plan, and I guess the core auto number for 2026 was $458 million within the $515 million. So that would be sort of the basis for translating into your 2027 number, which is closer to $400 million. Can we do that walk? So I guess some of it is fixed going from 40 to 20. But is it fair to say that there's also some backlog to revenue conversion even within core auto?
Stefan Ortmanns, CEO
I don't think it's so much the backlog conversion, although I think one of the things that we've done this year is we've continued to strengthen our insights into kind of all of our deals and how they roll out. That's why we provided the visibility chart on both embedded in and connected on the auto side and trying to break out the deals that are in production, the deals that will be SOP-ed but we've already won the business and then what contribution we need from new bookings and new deals over the next couple of years depending on what periods you're looking at. And then as we said, I think besides the prepay and the total again depending on which year you're looking at, most of it is reflective of the focused strategy on the technology roadmap and the product offerings that Nils talked about.
Chris McNally, Analyst
I wanted to discuss the connected services ramp mentioned on Slide 24. I appreciate you providing the information without Toyota. Looking at the endpoint for 2027, it appears to be around $80 million, which is significantly lower than the less than $50 million today. There was an expectation for a much larger increase in connected services, rather than the anticipated 5% to 6% compound annual growth rate. Could you explain the connected services projections? At one point, there was a forecast for $130 million to $140 million for connected services, excluding Toyota. Can you provide insight into the trajectory of those launches? Are many of the billings you’re currently receiving for connected services anticipated to come in after 2027?
Stefan Ortmanns, CEO
Yeah. It's a bit of that, but it's also, as I said, I think it's better visibility into how these programs are ramping. Some of the OEMs have changed how they're rolling this step out. It's not that we've lost the deals; it's just how they're rolling some of these bigger programs out across their model lines. And we have really high confidence in this multi-year target number. I mean, we still have a lot to deliver, but I think we're really confident about the ability to get this kind of 10% plus overall growth in the out years here as presented.
Operator, Operator
Thank you. Our next question comes from Jeff Osborne with TD Cowen. Your line is open.
Jeffrey Osborne, Analyst
Hey, good morning. Tom, I was wondering if you could flesh out the EBITDA impact to Toyota. You went through a lot on the revenue line, but between the moving pieces, what's the flow-through, in particular in fiscal 2025? The impact looks pretty substantial. Is there other variables that perhaps I'm not thinking of?
Tom Beaudoin, CFO
No. I think as I said to Jeff Van Rhee, you can pretty much assume that most of the revenue is at high 90% gross margin, and that's why you see some of the impact from some of the previous models to today. But we still end up with pretty strong mid-70s overall gross margins on the business. There was a few million dollars of deferred cost associated with that that will all get accelerated into Q1 along with the revenue. But that was a very, very high margin business. And again, with no cash because the cash was collected previously, and of course, the expenses were more on a deferred basis. So the cash associated with those came previously too.
Jeffrey Osborne, Analyst
Got it. And just two other quick ones. With the move from $40 million to $20 million on the license side, is there any risk to the OEMs accepting that, or have you already had conversations with them?
Tom Beaudoin, CFO
Well, if you recall, prepaid contracts are never done with OEMs. They're done with a small group of customers, predominantly in Japan and Korea, and they're also done on programs that are in production, right? And so they're really used as a cost-saving initiative for those Tier 1s. And just from a business standpoint, we just think it's the right thing for Cerence to try to continue to minimize the discounts that we have to give associated with those. And as we've talked about, what's happened over the years is that more and more the decision-making process is driven by the OEMs. They may ask us to contract through the Tier 1s. But the driver of our business these days is almost exclusively with the OEM. So we think there's minimal risk to continuing to try to limit the amount of those that we did. That being said, it's a kind of a weaning off process. So, as we said last year, we didn't go to zero. This year, we're trying to take it down by half, and we'll see how it goes in future years.
Jeffrey Osborne, Analyst
Got it. My last one is just the delayed SOPs of VW and others. Have you guys quantified what the impact was to fiscal 2023 results or the new guidance for 2024?
Stefan Ortmanns, CEO
No. No, not specifically for each OEM.
Jeffrey Osborne, Analyst
Is there a way of doing that in aggregate or is it not a substantial number?
Stefan Ortmanns, CEO
I think there are several factors affecting the numbers we presented last November compared to now. This includes the updates related to the bookings we made in fiscal 2023, the new production schedules for all of the OEMs, and the opportunities we need to pursue. From a visibility standpoint, the new deals we need to achieve these plans represent a relatively small amount. That’s why we have committed to updating the five-year backlog and visibility twice a year to provide better insights into how we plan to achieve these numbers moving forward.
Jeffrey Osborne, Analyst
Thanks. Appreciate it.
Operator, Operator
Thank you. There are no further questions. I'd like to turn the call back over to Richard Yerganian for closing remarks.
Rich Yerganian, Senior Vice President of Investor Relations
Thank you, Michelle, and thank you all for joining us on today's call. Apologizing for going a little bit late, but we had a lot of information to cover, and we hope to see and talk with you soon at various upcoming conferences and meetings, especially at CES. Thank you. Have a good day.
Operator, Operator
Thank you. This does conclude the program, and you may now disconnect. Everyone, have a great day.