Cerence - Earnings Call - Q1 2025

Executive Summary

• Q1 FY25 revenue $50.9M and adjusted EBITDA $1.4M both exceeded the upper end of guidance; free cash flow was $7.9M, aided by a $2.0M connected royalty true-up and lower non‑GAAP opex (-23% YoY) from restructuring and a $2.5M R&D tax credit catch-up.
• Q2 FY25 guidance: revenue $74–77M (incl. $20M fixed license), gross margin 74–76%, GAAP NI $1–5M, adj. EBITDA $18–22M; FY25 guidance unchanged at revenue $236–247M and adj. EBITDA $15–26M, with FCF $20–30M.
• Strategic progress: six design wins and two GenAI wins; first XUI Gen 1 customer program started; expanded NVIDIA collaboration to accelerate CaLLM/Edge development; momentum in SOPs (six major, two GenAI).
• Balance sheet/financing: repurchased ~$27M of 3.00% converts at 98.5% of par in Dec; plan to extinguish remaining ~$60M due June 2025 via cash and/or financing while maintaining cash flexibility.
• Near-term catalysts: execution of Q2 fixed license signings; additional GenAI/XUI program conversion; clarity on convertible notes resolution; potential guide update in May if macro/tariff developments warrant—management targets meeting/beat philosophy and upper-end FY25 adj. EBITDA/FCF.

What Went Well and What Went Wrong

What Went Well

• Beat on revenue and profitability vs guidance with positive FCF: “Top line revenue of $50.9M and adjusted EBITDA of $1.4M, both exceeded the high end of our guidance… strong free cash flow of $7.9M.”.
• GenAI product roadmap milestones and commercial traction: “delivering five proof‑of‑concepts and kicking off our first major customer program” for XUI Gen 1; six design wins (two GenAI) and two GenAI SOPs; NVIDIA/Microsoft partnerships to improve performance/cost.
• Cost actions delivered opex savings and margin outperformance: non‑GAAP opex fell to $34.1M (-23% YoY) with restructuring benefits; GM 65% beat the 60% high‑end guide on mix and PS margin improvement.

What Went Wrong

• YoY comps remain distorted by decommissioned “Legacy” Toyota contract: revenue -$87.4M YoY with $86.6M non‑cash revenue in Q1 FY24; GAAP net loss $(24.3)M vs $23.9M prior year.
• Penetration softness and China exposure: TTM penetration fell to 51% as global production mix shifted to China where Cerence has limited in‑country wins; shipped ~11.0M units in Q1, down 10% YoY; connected growth is improving but still early.
• Professional Services deceleration and variability: PS revenue declined to $14.5M and will be deemphasized (expected FY25 headwind) though margins improved >30%; Q2 absorbs ~$2M PS headwinds.

Transcript

Jason Gold (Head of Investor Relations)

Welcome to Cerence's First Quarter of Fiscal Year 2025 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, beliefs, outlook, strategy, goals, objectives, targets, and plans, should be considered to be forward-looking statements. Cerence makes no representations to update those statements after today. These statements are subject to risks and uncertainties, which may cause actual results to differ materially from such estimates, as described in our SEC filings, including the Form 8-K with the press release preceding today's call and our Form 10-K filed on November 25th, 2024. 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. The press release is available in the IR section of our website. Joining me on today's call are Brian Krzanich, CEO of Cerence, and Tony Rodriguez, CFO of Cerence. Please note that slides with further context are available in the investor section of our website. Now on to the call. Brian?

Brian Krzanich (CEO)

Thank you, Jason, and good afternoon, everyone, and welcome to the Q1 2025 Cerence earnings call, and I'm really excited to speak with you today. While Tony will walk you through the details, I have the pleasure of sharing our great Q1 results with you first. Top-line revenue of $50.9 million and adjusted EBITDA of $1.4 million both exceeded the high end of our guidance, and we had strong Free Cash Flow of $7.9 million. On our last call, I shared that our fiscal year 2025 goal is to return Cerence to profitability, a critical step to fuel the future growth. With our Q1 results, on a non-GAAP basis, we have moved toward profitability even earlier than we forecasted. I couldn't be more proud of what the team has accomplished and the great start this has given us for 2025.

In addition, during Q1, we repurchased 27 million of our convertible notes due in June of 2025. As we've discussed in the past, our plan is to extinguish this debt through some combination of repurchases and financing. We will decide the best path forward, taking into account shareholders' interests and with a view towards driving long-term value. As many of you know, but those who are new to the call may not, Cerence AI delivers AI-powered multimodal and conversational agent experience for automotive and beyond. We partner with the world's leading automakers and transportation OEMs to create AI-powered assistance, empowering them to deliver incredible user experiences to their drivers while also maintaining their unique brand and data ownership and keeping costs in line.

In addition to our deep technical expertise and our exciting product roadmap, more on that in a moment, the world's leading automakers and Tier 1 suppliers love to work with Cerence because we are a neutral and highly specialized supplier, living and breathing automotive and speaking the same language as our customers, unlike our competitors. With the ongoing challenges OEMs are facing, cost pressure, slowdown in EV and car sales, and an ever-changing geopolitical landscape, Cerence AI is uniquely positioned as the AI innovation partner who can help automakers deliver a premium experience while also navigating the impacts of a complex and rapidly changing industry. This quarter, the team has been laser-focused on our three key deliverables for 2025. First, continuing our work to bring Cerence XUI, our next-gen product based on our CaLLM family of language models, to market.

XUI's agentic multi-LLM architecture provides deep customization and enables compatibility with both new and existing infotainment systems, making it easier for automakers to deploy to both current and future vehicles. We reached several important milestones for XUI Gen 1 within the quarter, including delivering five proof of concepts and kicking off our first major customer program, further validating and solidifying our product and go-to-market strategy. And we've partnered with leading AI companies like NVIDIA and Microsoft, empowering us with tools and resources to deliver improved performance and cost efficiency to our customers and their drivers. These AI leaders are eager to work with us, given our position with global OEMs and installed base. And you'll see more announcements in this space as we approach NVIDIA's GTC in March and the Shanghai Auto Show in April.

The XUI Gen 2, which we are demonstrating now and will be available to our customers by the end of 2025, will deliver a single conversational interface that works across both cloud and embedded applications to complete tasks based on user preferences, integrating all aspects of a user's interaction into a seamless conversational interface that extends beyond voice. Our future product vision is to enable the driver to get into the vehicle and put their phone down, using their in-car system to complete the tasks they would normally do in their phone. In this new agentic world, we can combine activities like navigation, phone calling, text messaging, and web search that, even with your phone today, would require multiple steps and switching between various apps.

XUI brings the future of agentic and conversational AI to your vehicle and transforms the car into an assistant that saves you time and truly simplifies your life. The second key deliverable for 2025 is continuing to grow our business with new and existing customers. In this first quarter of fiscal 2025, we secured six new design wins across our current product line and two new wins for our generative AI solutions across large and global OEMs. We also saw start of production for six major customer programs and two generative AI programs within the quarter, including a large trucking customer and a major cloud win back in China and a Renault Avatar program that includes our Gen AI solution. The third key deliverable for 2025 is continuing our transformation and cost management. You've already seen the benefits of this work in our Q1 top and bottom-line results.

As I previously stated, we believe we should always be looking at how we can be more efficient from both a cost and operational perspective. For fiscal year 2025, we are focused on simplifying and streamlining our organization and our structure to continue taking cost and spending out of Cerence. We can find more efficient and productive ways to accomplish the same task, while also finding opportunities to vastly improve our speed to market and get exceptional products into the hands of our customers at a more rapid and competitive pace. This work is underway as we've continued to evaluate our office space and legal entities, kicked off a process to streamline and improve our relatively complex customer contracts, and continued to evaluate every rehire and new hire as we move forward. We're looking forward to fiscal Q2 2025.

We're issuing initial revenue guidance of $74-$77 million, with GAAP net income expected to be in the range of $1-$5 million, and adjusted EBITDA in the range of $18-$22 million, and Tony will provide further details on the second fiscal quarter in his remarks. Now, this is my second earnings call as CEO of Cerence AI, and I and the rest of the team are proud and encouraged by the first quarter results. Cerence AI is bringing conversational AI and true agentic capabilities to the vehicle now, not just in the future, and we have an exciting roadmap ahead. With that, I'll turn it over to Tony to go through the detail of our quarterly numbers, our guidance, and our restructuring activities. Tony?

Tony Rodriguez (CFO)

Thank you, Brian. Today, I will be reviewing our Q1 results for fiscal year 2025 and providing some guidance for our second quarter. I will also comment on our progression toward full fiscal year 2025 guidance. Let's get into the Q1 operating statement. At the top, we achieved Q1 revenue of $50.9 million, which exceeded the high end of our guidance range of $47-$50 million. Our revenue this quarter was aided by $2 million in connected royalty true-ups for one of our OEM customers. As a reminder, this is normal as our customers self-report royalty volumes that approximate their auto shipments with our technology each quarter and periodically true-up to actual. With this revenue achievement, our gross margin for the quarter of 65% also exceeded the high end of our guidance of 60%.

Gross profit was also benefited from a greater mix of higher margin license and connected services revenue as compared to professional services revenue. While our professional services revenue was lower than anticipated during the quarter, it performed at a higher gross margin than anticipated. Moving down the operating statement, our non-GAAP operating expenses were $34.1 million for Q1, compared to $44.4 million from the same quarter in fiscal year 2024. This decrease of $10.4 million, or 23%, represents a full quarter of savings from the restructuring efforts conducted at the end of last year. We also delayed some planned R&D hiring until Q2. Additionally, the company received notice of acceptance of an international tax credit that allowed us to record $2.5 million in operating cost benefit.

The tax credit benefit recognized this quarter related to 2021 through 2024 fiscal years and was anticipated in our full-year guidance, but later in the fiscal year. Our Adjusted EBITDA of $1.4 million well exceeded our guidance of loss in the range of $6-$9 million. This was driven by improved gross profit as well as decreased operating expenses from continued effort of managing our ongoing operating costs and the previously discussed international tax credit of $2.5 million. As compared to prior year, our Q1 revenue declined $87.4 million, but this was driven by $86.6 million of non-cash revenue recorded in last fiscal year associated with our legacy connected services contract that was decommissioned in Q1 of fiscal 2024. Our net loss for Q1 was $22.4 million compared to net income of $23.9 million for the same quarter in fiscal 2024.

Again, the decline driven by the decommissioned legacy contract. We ended the quarter with $110.5 million of cash and marketable securities, down $19.9 million compared to where we ended last fiscal year. The lower cash balances quarter related to our repurchase of $27.4 million in principal value of our 2025 convertible notes, offset by our positive Free Cash Flow during the quarter of $7.9 million. Our cash flow in Q1 absorbed approximately $8.9 million of cash restructuring costs associated with the transformation efforts of Q4 last year. We believe the good start to the year positions us well to achieve our full-year cash flow expectations. During the quarter, we recorded restructuring and other costs of $11.1 million, which included a $10.2 million charge primarily related to our transformation initiatives, of which $3 million related to accelerated stock-based compensation associated with the termination of former senior management employees.

As we look at our revenue breakdown and operating metrics, variable license revenue of $22.7 million was up $1.9 million, or 9.1%, from the same quarter last year and slightly ahead of our expectations. As planned, there was no material fixed license revenue during the quarter. Q1 connected services revenue of $13.7 million was up $3.5 million, or 34%, from $10.2 million the same quarter last year when excluding the legacy revenue. We believe this reflects a positive trend of increased demand for our connected vehicles. As planned, our professional service revenue was down year over year. However, the work performed was more profitable than a year ago.

As we review our key performance indicators this quarter, total adjusted billings, which are defined as our total billings adjusted to exclude professional services, prepaid billings, and prepaid consumption, was $227 million, an increase of 3% for the trailing 12-month period this year compared to the previous year. Total billings, including professional services for Q1, of $69 million, were up 7% compared to $64.6 million for Q1 last year. As a reminder, when we look at our total license shipments, pro forma royalties is an operating metric we use representing the total value of variable license shipments in a quarter, including the shipments from fixed licenses where revenue was previously recognized upon contract signing. We refer to shipments where revenue was recognized in prior periods as fixed license consumption.

Our pro forma royalties were $36.7 million, which were higher by approximately $1.4 million as compared to Q1 last year and in line with our expectations. Consumption of previously fixed contracts totaled $14 million this quarter, lower than the same quarter last year by about 3% and lower than projected. Going forward, we anticipate a lower level of consumption of royalties associated with past fixed license contracts. Our penetration of global auto production for the trailing 12 months declined by 51%. We shipped approximately 11 million cars with Cerence Technology in Q1, up 2.6% compared to last quarter, though down 10.5% year over year. Q1 worldwide IHS production declined 1.2% compared to the same quarter last year and was up 10.8% quarter over quarter. Excluding China, worldwide car production was only up 2.8% quarter over quarter and down 4.8% versus the same quarter last year.

This is important to note as this shows that part of our worldwide penetration decline relates to the increase in China production within worldwide auto production. To date, we have not been significantly successful at selling to Chinese OEMs into the Chinese domestic market. Weaker production volumes among our top customers also contributed to our year-over-year total volume decline. That said, the number of cars produced that use our connected services increased 5.1% on a trailing 12-month basis compared to the same metric a year ago and 5.6% compared to last quarter. This reflects the increased demand for connected vehicles. Now turning to our guidance. For Q2, we currently expect revenue to be in the range of $74 million-$77 million. This includes $20 million of projected fixed license revenue expected to be signed during the quarter.

Additionally, our Q2 revenue guidance absorbs approximately $2 million of headwinds in professional services we saw in Q1. We are not projecting any additional fixed license revenue for the remainder of the year. With the level of fixed license revenue forecast in Q2, we expect gross margins to improve to between 74%-76%, net income to be in the range of $1-$5 million and adjusted EBITDA to be in the range of $18-$22 million. When taken in the context of our full-year guidance, this means that the implied second-half guidance for adjusted EBITDA would be negative if you simply based your calculations off the midpoint of our range. To be clear, this is not our intention to signal any change in direction of the business.

Rather, it is still early in the year, and as mentioned, Q1 was aided by a few timing-related factors on the expense side that will catch up to us later in the year. With that said, we had a positive first quarter, but are not yet prepared to officially revise our fiscal 2025 revenue, profitability, and cash flow guidance. The strong start to the year positions us very well and gives us confidence that our full-year numbers are likely to come in toward the top end of the range of our guidance that we gave last quarter, especially full-year Adjusted EBITDA and Free Cash Flow.

When looking at our liquidity, as previously noted, we repurchased $27.4 million of outstanding 2025 convertible notes. As Brian mentioned, our plan is to extinguish the remaining $60 million of convertible notes due in June through some combination of payoff and financing. Between now and June, we will continue to evaluate potential capital structures that could position the company to execute our longer-term strategic direction while also allowing us to retain a cash reserve to be flexible as we move forward. Overall, we are pleased with the solid results for Q1 and our continued financial performance. I will now turn it back to Brian to close our remarks.

Brian Krzanich (CEO)

Thanks, Tony. In closing, we're happy with our Q1 results and motivated by our Q2 forecast. We remain focused on execution, business process improvement, cost reduction, and advancing our next-gen roadmap. Now, before we close, I want to take a moment to explain my philosophy on forecasting. We take our commitment to the street seriously, and our goal is always to meet or beat our forecast. I have a firm policy not to change guidance after the first quarter. Our first quarter results and second quarter forecast give us confidence in our fiscal year 2025 forecast for revenue, and we are projecting to be in the upper end of the range for Adjusted EBITDA and Free Cash Flow.

With regards to the recent tariff announcements, we don't believe that there will be a meaningful impact to Q2, as we're already halfway through the quarter, and the recent tariffs were paused earlier this week. Now, for the rest of the fiscal year, considering the number of changes that have occurred just in the last several weeks, we believe the situation is still incredibly fluid. It would be too speculative for us to say what, if any, impact there will be on our results at this time, and we'll provide an update on our next earnings call in May if there is meaningful impact.

We continue to believe in our ability to deliver on our Q2 and fiscal year 2025 guidance, and in our growth for fiscal year 2026 and beyond, and we look forward to continuing to share our progress with you. We'll now open it up for questions.

Operator (participant)

Thank you, ladies and gentlemen. If you have a question or a comment at this time, please press star one one on your telephone. If your question has been answered or you wish to move yourself from the queue, please press star one one again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Nick Doyle with Needham & Company. Your line is open.

Nick Doyle (Equity Research Analyst)

Hey, guys. Thanks for taking my question. The design win and SOP commentary is really positive. So two questions there. How big can that first major customer program with Cerence XUI be? And second, how many units or any help around sizing the six SOPs that are expected to really start here? And how does that impact your PPUs going forward? Thanks.

Brian Krzanich (CEO)

Sure. So Nick, this is Brian. I'd tell you that the first one is with a European auto manufacturer. If you look over the life of the contract, it's several million units. I think in the first year, it's roughly a million-ish, maybe slightly less. And we're seeing the PPU upgrades that we've talked about in the past. Tony's going to talk to you a little bit about PPU after I'm done here because we really have a plan to start bringing PPU to you guys starting in the next quarter. If you take a look at the rest of the POCs that we have going, it's with all of the major OEMs just about in various levels of completion or start. And so again, it could be for the X Gen 1 that we're looking at right now, it could be multiple millions of units as we move forward.

We're seeing the PPU upgrade that we expect for this product. There's interest, and we're getting paid for the product we bring. This technology is really the beginning of the agentic connected vehicle model that we have, and it will continue in X Gen 1 and then X Gen 2 as well.

Nick Doyle (Equity Research Analyst)

Thanks. Go ahead.

Tony Rodriguez (CFO)

Yeah, hi, Nick. Yeah, I mean, just bridging that on PPU. We've talked in the past on these calls that we really need to simplify the model and get to a volumes, times, price model effectively. What we can say, we're not prepared to guide on PPU or effective PPU going forward at this point. By next quarter, we will, and we'll be able to give you more of these volume questions and PPU questions. But what I can say is there's really two fronts to us growing our PPU, and I'll comment a little bit about how we are kind of seeing that trajectory. But the two fronts are the number of connected cars, how many of our overall cars shipped are connected.

The second is the price with the additional features of these newer products on the connected side that increase in price and how it's driving our effective PPU. And again, at this point, though, I'm not prepared to provide a number. I will say that our effective PPU is really thinking about our license revenue in a quarter for those cars shipped, so the revenue divided into those cars shipped. And then on the connected side, it's the volume of the connected vehicles times really divided into the billings. Because as we've talked about before, those billings are then recognized over a subscription period. So we want to get to an effective PPU. What was the value of those cars shipped?

What I have seen kind of a precursor to next quarter is that we are seeing the benefits of those two fronts, the increased number of connected cars and the increased price impacting positively and growing that effective PPU number.

Nick Doyle (Equity Research Analyst)

Really helpful. Thank you. And then second, billings is trending in the right direction. Can the conversion of some of what's in the pipeline today get you to the $290 million that you talked about? And then if I could just squeeze in, why take in all the fixed contracts this quarter? Thanks.

Tony Rodriguez (CFO)

Yeah, two things. Yeah, so yeah, the number that the company has historically given on is trailing 12 months billings, right? And we quoted that as $227 million of trailing 12 months adjusted billings. And again, it's adjusted for not including billings related to professional services and then gives up and down associated with previous fixed and current fixed. So that's a good number. We've talked about the billings this quarter will outpace our projected revenue. And again, our projected revenue, which we have not re-guided, is $236 million-$247 million. So again, the billings outpacing that, I think we're on track to certainly do that. The second question, what was the?

Brian Krzanich (CEO)

So the second question was, why do all the prepay now? And really, it's just a combination, Nick, of customers and what we're able to negotiate. You've got to remember, the prepays come with a discount. And in the past, that discount was often quite high. And by shrinking the total footprint that we're going to do down to 20 million and really being more selective and making sure that with deep partners and the right discounts, we're able to get this discount down to record levels.

So it was really we had more demand than we had budgeted of 20, and we got the right discounts, and so we went ahead and administered it. That's why we always, Tony and I always say, you really need to look at the full year. There's going to be lumpiness in our numbers quarter to quarter, but it's just right customers, great discounts, lower than we've almost ever achieved, and it's the right thing to do now.

Tony Rodriguez (CFO)

Yeah. And lastly, the timing. In these cases, these customers with those lower discounts and everything that Brian said are coming to a point where their previous fixed is now consuming down to a point where they want to re-up that prepayment, and it fits into their fiscal year as well, which starts April 1st or, well, sorry, within this quarter. So they want to get it ahead of the next quarter. So I think all those things are why we would do it. It's not that we planned per se to do it. We're being opportunistic with that $20 million.

Nick Doyle (Equity Research Analyst)

Thank you.

Operator (participant)

One moment for our next question. Our next question comes from Mark Delaney with Goldman Sachs.

Mark Delaney (Analyst)

Yes, good afternoon. Thanks for taking the questions. It's good to hear about the breadth of your customer engagements and momentum with your GenAI solutions. I'm hoping you can expand a bit more on that topic and maybe speak to the competitive landscape for digital assistants and any sense of how your market share may trend relative to what you'd seen with your traditional products.

Brian Krzanich (CEO)

Sure. So I tell you that the competitive landscape is really pretty much what it was last quarter as well. We continue to see some of the big players like Google and Amazon in there. We see some of the, I'll call it, software providers like ourselves. We see SoundHound and some of the others. And then we see some, I'll call it DIY, where there are either SSE providers or some of the OEMs starting. Now, what happens is they're biting off bits and pieces, and they're oftentimes being very prescriptive in some of the things like they must be connected or you're locked into certain LLMs. So our approach to that is always, hey, we're agnostic. We can use the latest and greatest LLMs. You can choose. We can customize. You can choose customized wake-up words.

A good example was Renault's Avatar, where we customize the wake-up word around Reno, which is their avatar's name, and really customize the user experience. And that's really how we approach these. And then we offer embedded capabilities that are quite strong. And as we move through this year, get even stronger. Next Gen 2, and this is what Microsoft's really helping us with around the CaLLM embedded LLM capabilities, shrinking the footprint and getting true agentic LLM capabilities embedded in a car, which means we have to get small footprint from memory, the right sizing of the SOC, and being able to get it capable of having the right latency. Those are all the things that we compete with. But otherwise, the competitive landscape hasn't really changed.

Mark Delaney (Analyst)

That's helpful context, Brian. Maybe too soon to try and quantify, but I mean, the share of market, do you think it's similar to what you've seen before? Do you think you can maybe gain some share with all the traction you're seeing?

Brian Krzanich (CEO)

Yeah. So I mean, Tony tried to kind of walk you through. And basically, if you look at the OEMs that we typically participate in, which are the, let's call it the Western OEMs, our market share is relatively flat in that space. What we're seeing is China inside of China, which is taken away from our traditional OEMs. And our ability to progress into China in China has not been there yet.

And we're continuing to look at options and ways to do that. We believe our technology competes very well in that space. It's all about basically national winners that they're selecting. Now, China outside of China, we have good relationships and are in BYD and Zeekr and Great Wall, NIO. So we're in some of the Chinese outside of China. But if you look at the OEMs that we typically, the Western OEMs that we typically play in, our market share is relatively flat. Yes.

Mark Delaney (Analyst)

Got it. One last one for me. Just on the restructuring actions, I think you said on the last call you expected to be at the high end or maybe even somewhat above the $35 million-$40 million annualized target. Maybe update us on where that came in. And I think you said it's all in place exiting the fiscal first quarter. But just to clarify where you stand on cost action and if there's any more to come or it's all in place. Thank you.

Brian Krzanich (CEO)

So I can start that, and Tony can answer in more detail. I think also, Mark, I may not have completely answered your first question. So I do think we will, in the OEMs that we play with or that we participate with, we will gain share. Our target is to gain share. We saw a win back in China around the cloud. We're continuing to drive, we believe, a leading-edge roadmap of products. So our goal is to continue to gain share in the guys that we typically play with. And then we're aggressively seeing what we can do inside of China. Now, your question was cost reduction. Your second question was around cost reductions and cost improvements. I tell you that what we've already forecasted for 2026 or, excuse me, for 2025 is work that's for the most part already done.

So you're seeing the results of it filter through the cost system. So whether it's headcount reductions or site closures or site reductions, things like that are already filtering through as the year goes on. We do have a set of programs that I talked about that we're continuing to look at and drive. And if we take something like improving our contracts and the efficiency within our finance unit, that's work Tony has ongoing right now. That work will probably take through at least halfway through this year and into probably the second half of next year. And you're really going to see the benefits of that one roll into 2026.

It's hard for us to forecast right now because as we look at things like reducing the number of legal entities or improving how we financially account for things and improving and streamlining that, we're still trying to figure out how do we account for how much effort and work does that remove from the system and spending. How many fewer tax returns do we have to do? How many filings do we not have to do? Most of those will roll into 2026 for additional cost reductions as we move forward.

Operator (participant)

Thanks. One moment for our next question. Our next question comes from Colin Langan with Wells Fargo. Your line is open.

Colin Langan (Director and Senior Equity Analyst)

Oh, great. Thanks for taking my questions. You mentioned you got it to the high end of the range. You said there were some factors in Q1 that were outliers. Could you just remind me what they are? It was the $2 million of royalty true-ups and then the $2.5 of tax credit. Are those the items you're referring to that were kind of better than expected?

Tony Rodriguez (CFO)

Yeah, yeah. A couple of the one-time items. We say one-time items, and I'll talk through a couple of it. One is the true-ups. And as our royalty reports come in, our OEMs and Tier 1s report royalties. They report, and then they oftentimes will true-up the actual report, estimate a number, and true-up the actual. So in this case, there was a connected services contract, and we did some work with an OEM and wanted to make sure we were capturing all of our activity and got $2 million of a true-up for past. So some of that was in the quarter of that $2 million. So it would have hit the quarter as well. And then some of it is before the quarter. But even if you take that $2 million away, we were kind of smack dab in the middle of our guidance.

This put us over the edge on guidance on the top line. The tax credit was something that was baked into our full-year expenses. We just happened to get confirmation of that credit in Q1, so we were able to record it for previous years, the years 2021 through 2024 in Q1, where we had had that baked into savings of OpEx for fiscal 2025, but not necessarily in Q1. So those were the two main items that drove improved profitability to the bottom line.

Colin Langan (Director and Senior Equity Analyst)

The tax credit wasn't treated as a special item.

Tony Rodriguez (CFO)

I'm sorry, say that again.

Colin Langan (Director and Senior Equity Analyst)

The tax credit wasn't a special adjustment on special item adjusted out.

Tony Rodriguez (CFO)

Yeah. The tax credit was an OpEx credit. It's an international tax credit associated with offsetting R&D costs. And so in previous years, we incurred the entire cost for this country without the savings of the credit. This was a catch-up for that country. And again, that $2.5 related to 2024 and before. So we will have some savings in 2025 as well, the rest of the year for the 2025 expectations for that credit. But that was kind of the catch-up.

Colin Langan (Director and Senior Equity Analyst)

You mentioned in the closing commentary about tariff risk. I was a bit surprised. I kind of assumed software wouldn't have much risk. Where is your tariff exposure if there are tariffs? How should we be thinking about that if you could frame it?

Brian Krzanich (CEO)

Sure. It would just be in unit volume. So if the projections were at one point that if the tariffs were applied, it could affect 25% of the cars and multiple thousand-dollar increases in cost. And so if people buy fewer cars, that's when we get paid from a shipment standpoint, right? So it would be purely volume. So we don't get we are a U.S. company, and so at least right now, the talk of tariffs, it doesn't apply, quote, to our product, but it applies to the or would have applied potentially to our customers' products. And that's all we were counting against.

Colin Langan (Director and Senior Equity Analyst)

No, that makes sense.

Brian Krzanich (CEO)

As I said, right now, they've all been put on hold, and we're halfway through the year, so we don't see it right now. It's just an impossible prediction.

Colin Langan (Director and Senior Equity Analyst)

Got it. And just lastly, you talked about XUI. How quickly can this ramp? How quickly can adoption be? Because are contracts two to three years, or is this something that could be added and drive that pricing higher in the next year or two pretty quickly?

Brian Krzanich (CEO)

Sure. So you have to remember that there's two versions of our agentic large language model software version that we think about. One is an embedded, non-connected version, and the other one is a connected version. And the connected version gives you the ability to do things like, "Hey, what was the latest score on the football game?" or, "Who won La Liga this weekend?" It gives you real-time data. It also gives you points of interest that are updated and all of that kind of information. But it's not required to run the car, do navigation. Those are all embedded efforts. Typically, the cars come from anywhere. Tony and I were talking about this this morning.

From one to we've seen as long as 10-year contracts for connectivity. I tell you that the majority of them are probably somewhere in that two to three years. At that point, the customer, the end user, the driver makes some agreement with the OEM, the manufacturer of the car, to continue connectivity at some rate. We don't drive that. And we're just it's the early days of seeing what the re-sign-up is for people. So we don't really have a forecast for that. When we look at this, we look at just most cars are being connected as we ship them. What's that rate? And that's how we project through 2025 and all from that perspective because most of those cars are going to still be within the one-year to three-year terms.

Colin Langan (Director and Senior Equity Analyst)

Got it. All right. Thanks for taking my questions.

Operator (participant)

One moment for our next question. Our next question comes from Jeff Van Rhee with Craig-Hallum Capital Group. Your line is open.

Daniel Kapke (Institutional Equity Sales)

Hey, Brian, Tony, this is Daniel on for Jeff. Maybe just sort of as an example of the sort of places where you're seeing momentum, if you could speak to that Chinese win-back you mentioned. Maybe just describe that deal in a little bit more detail, what that bake-off was like, how you won, why you won, etc.

Brian Krzanich (CEO)

Sure. So that one was with a Western OEM's cloud infrastructure. And we won based on, again, the technology leadership that we provided and our willingness to be much more flexible and configure their cloud system exactly how they wanted. So it was a win-back that we'd had against a very strong competitor, prior local competitor.

Daniel Kapke (Institutional Equity Sales)

Okay. That's helpful. And then just on connected, either for Brian or Tony, just on the metrics that we should be looking at, a few different ways we could read this in new connected. I guess if you exclude the $2 million true-up this quarter, I guess it's down sequentially. It's up single digits year over year. The trailing 12-month car shipped has grown 5%, but a little bit of a deceleration from last quarter. Just a bunch of different ways we could read that. How would you, cutting through all that, speak to the metrics? What's the most relevant? How should we be looking at the trajectory there?

Tony Rodriguez (CFO)

Yeah. So I think there's a couple of ways to look at it as we think about our two fronts of growth with regard to connected, right? Is the number of connected cars, the connected rate? So for every car that ships out, how many of those are connected? And then two, what is that price per unit that we're seeing over both connected? Is that growing as we anticipate? And how is that contributing to overall DPU? So it's those two fronts. What I would say is that we're not ready to provide that guidance right now on connected rates and PPUs. And then the second one is, or the third one would be billings. So just remember too that if a car ships out with a connected, at that time, we're billing for two things. One is the embedded license, which drops to revenue right away.

And then the connected, which then gets recognized over the future. That's why the first question was, "Hey, what's your billings? Are you on track for your billings this year?" which will outpace our GAAP revenue because connected billings will be billed but not recognized until the future. And we don't break apart our billings between licensed and connected. So there's components that if you're trying to model are missing. And we know that it's important to you. It's important for us to know to be able to give you that information to help you model. But that's really next quarter. But I think the things you need to think about as we go forward are the connection rate, the price per unit on the connected side, the price per unit overall of a car shipped, and then lastly, the growing billings within connected.

Daniel Kapke (Institutional Equity Sales)

And then just last for me, just a modeling question on the professional services COGS dipped below $10 million this quarter. I think first time we've ever seen that. And that's kind of been a little bit of a trajectory over the past year where those COGS have been going down. Is that sustainable? Is that structural? Is that one time just sort of our expectations for PS COGS?

Tony Rodriguez (CFO)

Yeah. So yeah, so PS is down, as we've said. What I mentioned in the call is that our margin for PS is actually improved. I think we typically plan that business, see that business as a 30% margin business, which brings down our overall margin. This quarter, it was north of that, which was beneficial to us. So overall, COGS were down because professional services revenue was down. But also for what we did sell, we sold it at a higher margin. So as you think about modeling, you could probably model professional services margins at north of 30% now.

Daniel Kapke (Institutional Equity Sales)

Okay. Thanks, Brian. Thanks, Tony.

Operator (participant)

One moment for our next question. Our next question comes from Jeff Osborne with TD Cowen. Your line is open.

Jeff Osborne (Managing Director and Senior Research Analyst)

Yeah, thank you. Just two quick ones from my side. One, I think it was last quarter, you gave some usage stats on the GenAI platform. I want to say it was maybe June, July that your first customer in Europe pushed that update into the install base. Is there any metrics you can share about usage of the newer platform relative to the older conversational AI, non-AI solutions?

Brian Krzanich (CEO)

I don't have any, Jeff, any new metrics. I tell you we're continuing to see increased usage. Just if you look at our cloud traffic, that, as the generative AI connected vehicles go out, we're continuing to see our cloud usage increase as well. But I don't have any new numbers for you from that perspective. But it is getting used.

Jeff Osborne (Managing Director and Senior Research Analyst)

Wasn't sure if there's a halo effect in particular as you had an installed base of, I think it was the ID.3s and 4s, if my memory is right, that new users were using it for a month or two, and then that tapered off. But it doesn't sound like that's the case. Is that right?

Brian Krzanich (CEO)

That's not what we're observing yet. No. We are continuing to see, and in fact, one of the biggest things we work on is really helping end users understand just what the car is capable of doing, so what we're finding is as users see all they can do with voice in their car with these connected cars with the GenAI, they're using it more and more.

Jeff Osborne (Managing Director and Senior Research Analyst)

That's great to hear. My last question is just as we approach the June deadline for the debt, remind us, is there a minimum cash balance that you feel comfortable having? Obviously, you've got a nice EBITDA guidance here for Q2. I assume you generate nice Free Cash Flow. But as you think about paying off the remaining tranche, how should we think about the options and then what the minimum cash balance you feel comfortable having?

Tony Rodriguez (CFO)

Yeah. We don't have a minimum per se. That said, we're very comfortable with paying it. If we pay it off and don't refinance any, we'll likely be north of $70 million at the lowest point. So is that the exact right number? That's what we're looking at as far as overall capital structure to see where we want to be. But we're comfortable that if we need to, we can continue to grow the cash flow of the business and grow from a lower point of $70 million of cash after the payoff to where that optimal amount is.

Jeff Osborne (Managing Director and Senior Research Analyst)

Got it. That's all I had. Thank you.

Operator (participant)

I'm not showing any further questions at this time. I'd like to turn the call back over to Brian for any remarks.

Brian Krzanich (CEO)

Okay. I would just like to reiterate we're really proud of our Q1 results. You saw our forecasts for Q2, and we've also said that for the full year, we're comfortable in saying we'll be in the upper end of our guidance for both Free Cash Flow and Adjusted EBITDA. We are really driving hard as we enter Q2 into continuing to push our Generative AI development work and doing our POCs at the customers, and we look forward to talking to you in May to give you an update and the progress on all of those, and with that, I'd just like to close the call with a thank you very much, and I look forward to talking to you all in May.

Operator (participant)

Thank you, ladies and gentlemen. This does conclude today's presentation. You may now disconnect and have a wonderful day.