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Rating Action:

Moody's assigns B2 CFR to Cerence in connection with spin-off and new debt issuance; outlook positive

10 Sep 2019

$425 million of funded, rated debt affected

New York, September 10, 2019 -- Moody's Investors Service ("Moody's") assigned a B2 Corporate Family Rating (CFR) and B2-PD Probability of Default Rating (PDR) to Cerence LLC ("Cerence") in connection with the company's expected spin-off from, Nuance Communications, Inc. ("Nuance" Ba3, Stable), and Cerence's concurrent proposed debt financing. Cerence's proposed $425 million senior secured term loan B and $75 million revolving credit facility were assigned ratings of B2, in line with the CFR. Moody's also assigned to the company an SGL-1 Speculative Grade Liquidity Rating. The rating outlook is positive. Proceeds from the proposed senior secured term loan B will be used to fund a portion of the cash of $110 million to Cerence's balance sheet following the spin-off, distribute $310 million to Nuance, and fund estimated transaction fees and expenses.

Assignments:

..Issuer: Cerence LLC

.... Corporate Family Rating, Assigned B2

.... Probability of Default Rating, Assigned B2-PD

.... Speculative Grade Liquidity Rating, Assigned SGL-1

....Senior Secured Term Loan B, Assigned B2 (LGD4)

....Senior Secured Revolving Credit Facility, Assigned B2 (LGD4)

Outlook Actions:

..Issuer: Cerence LLC

....Outlook, Assigned Positive

The assignment of ratings remains subject to Moody's review of the final terms and conditions of the proposed financing that is expected to close during the 4th quarter of 2019.

RATINGS RATIONALE

The B2 CFR reflects Cerence's high initial leverage pro forma for the proposed financing and the risks associated with setting up the company as a standalone business. For the LTM period ended June 30, 2019, Moody's adjusted leverage was 6.0x but if adjusted for stock-based compensation, leverage could be viewed as 4.4x. Moody's forecasts adjusted leverage to be roughly 5.0x in 12 months. A substantial portion of separation efforts have already been completed however, Cerence management will have to ensure key personnel are appropriately staffed to replace transition services agreements with Nuance and comply with operational restrictions to complete a tax-free spin-off.

The rating also considers both Cerence's limited end-market diversification given that its largest customer, Toyota Motor Corporation , represented 19% of revenue in 2018 as well as Cerence's highly focused product offerings that are tailored only to automotive applications, an end market which faces near-term headwinds. Moreover, Cerence is significantly smaller in scale relative to both its customers and certain of its competitors. For example, large technology companies with sizeable cash on hand such Google Inc. ("Google"), Baidu Inc. ("Baidu Inc."), and Samsung America Inc ("Samsung") currently co-exist with Cerence as third-party virtual assistants, but have the potential to pivot into Cerence's market.

The rating is supported by Cerence's leading market position, customer relationships with nearly all major global automotive OEM's and/or their tier 1 suppliers, expanding market supported by secular tailwinds, and highly profitable software offerings. With EBITDA margin of 30% as of FY2018, Cerence is expected to achieve free cash flow to debt of around 10% in the next 12-18 months. Such strong profitability drives a strong free cash flow profile which may be somewhat hampered in FY2020 by the ongoing stand-up costs. Cerence seeks to position itself as agnostic to the tech ecosystem for embedded and connected voice assistance technologies for automotive applications. In turn, Cerence also seeks to benefit from secular trends including vehicle intelligence, virtual assistants, distracted driving, and shared mobility by offering digital platform solutions that are compatible with third-party providers such as Google, Amazon.com, Inc., Samsung, and Baidu.

Though leverage is considered high, Moody's expects that Cerence will maintain a moderate financial strategy over time. The company will be publicly traded and has a diverse and largely independent board of directors.

The positive outlook reflects Moody's expectation that Cerence will generate high-single to low double-digit percent FCF / debt over the next 12-18 months. The positive outlook also anticipates continued organic revenue and EBITDA growth in the mid-to high single-digit percent range which is expected to drive leverage toward 4.5x on a Moody's adjusted basis over the next 12-18 months. Ratings could be upgraded if Cerence continues to grow organically and increase in scale as well as sustain leverage below 4.5x and FCF / debt above 15%. Ratings could be downgraded if leverage were sustained above 6x, if FCF/debt were to decline below 5% or if the company experienced material deterioration in liquidity.

Cerence's liquidity is considered very good, as reflected by the assigned SGL-1 speculative grade liquidity rating. Liquidity is supported by an expected closing cash balance of $110 million, which is ample to support ongoing efforts to separate the business from Nuance, as well as a $75 million revolving credit facility which is expected to be undrawn at the close of the transaction.

The B2 rating for Cerence's proposed bank credit facilities reflects a B2-PD Probability of Default Rating and the company's covenant-lite, single class debt structure.

The principal methodology used in these ratings was Software Industry published in August 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Cerence is a provider of embedded and connected in-vehicle driver assistance technologies powered by the company's speech recognition and natural language understanding software capabilities. Pro forma revenue is expected to be about $305 million for the fiscal year ended September 30, 2019. Cerence is headquartered in Burlington, MA.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Stephen Morrison
Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Stephen Sohn
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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