SOUN - NASDAQ

Good day, and welcome to the SoundHound Q1 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Scott Smith, Head of Investor Relations. Please go ahead.

Great. Thank you. Good afternoon and thank you for joining our first quarter 2023 conference call. With me today is our CEO, Keyvan Mohajer; and our CFO, Nitesh Sharan. We will begin with some short remarks before moving to Q&A. We'd also like to remind everyone that we'll be making forward-looking statements on this call. Actual results could differ materially from those suggested by our forward-looking statements. Please refer to our filings with the SEC for a detailed discussion of the risks and uncertainties that could affect our business and those that qualify as forward-looking statements. In addition, we may discuss certain non-GAAP measures. Please refer to today's press release for more detailed financial results and further details on the definitions, limitations and uses of those measures and reconciliations from GAAP to non-GAAP. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We undertake no obligation to update any forward-looking statements, except as required by law. Finally, this call is being audio webcast in its entirety on our Investor Relations website. An audio replay will be available shortly following today's call. With that, I would like to turn the call over to our CEO, Keyvan Mohajer. Please go ahead, Keyvan.

Thank you, Scott, and thank you to everyone for joining the call today. The start of 2023 was a pivotal time for SoundHound and our path to sustainable and profitable growth. During the quarter, we raised a significant amount of capital, streamlined our organization, reduced our expenses. And with the launch of SoundHound Chat AI, we unveiled our innovative approach of integrating Generative AI and large language models into our full stack of technology for conversational voice AI. And while the first quarter was a transition quarter for us, we overachieved our targets and grew our revenue by 56% year-over-year. In our Pillar 1 of revenue, where we power devices such as cars, TVs and IoTs, we have added several new brands, including a transformational Turkish automotive manufacturer of electrical vehicles. We have also expanded our global reach by adding two brands associated with the Stellantis Group and now have 10 brands with them in total. Additionally, we signed a new revolutionary television manufacturer, which is expected to launch later this year. We also closed a new deal with the multinational electronics company and one of the world's largest manufacturers of printers. In Q1, the number of cars shipping with SoundHound's technology more than doubled year-over-year, and we expect the growth to accelerate as more brands sign up and existing customers' experience. In our Pillar 2 of revenues, where we power customer service applications, we have signed up hundreds of new brands. It's important to note that our AI customer service solutions are fully autonomous, which is different from the human-assisted AI solution that other vendors are offering in this particular field. This key differentiator, in addition to giving us much better margins also enables us to attract brands of all sizes from a single location to thousands of locations. Our newly launched SoundHound Chat AI platform is already positively packing both Pillar 1 and Pillar 2 revenues. In Pillar 1, we are seeing demand from existing customers and new brands. We expect faster adoption, better user experience, more frequent usage and ultimately, more revenue per device from our Pillar 1 customers. In Pillar 2, we are expanding our AI customer service solutions from restaurants to other businesses. We have always envisioned that restaurants are to SoundHound what books were to Amazon. They started by selling books, then over time, expanded to other categories, eventually everything from A to

Thank you, Keyvan, and good afternoon, everyone. We are pleased to report another strong quarter with 56% year-over-year top-line growth while demonstrating steady progress in driving efficiencies and improving cash flow. In the start of the year, we set out to significantly strengthen our liquidity position, and we have now done that. We initially raised enough capital to see us through to profitability, and just last month, we closed our new debt refinancing that will fund us well beyond that. Despite a choppy funding market, we were able to successfully execute these financings on the foundations of our technology and deep patent portfolio, along with significant customer adoption in attractive end markets. We also stay focused on the business and the opportunity in front of us. Artificial intelligence is rightly getting a lot of attention these days and our opportunity has only expanded. At SoundHound, we make conversations with technology more natural and seamless, and the demand for that has only become stronger. Large language models, Generative AI and the pervasiveness of chatbots are unearthing entirely new use cases every day. The opportunity set and adoption curves will accelerate rapidly, and we are at the forefront of this next major inflection in technology. We continue to expand our voice-enabled ecosystem and had strong growth, even with Q1 typically our seasonally smallest quarter of the year from a revenue standpoint. This could have only been possible with our strong customer engagement and streamlined execution that we expect will only further improve from here. Our business model is grounded in the three Pillar revenue framework. Pillar 1 represents voice-enabled products where we receive royalties. Pillar 2 represents voice-enabled services, generally under monthly subscription contracts, and then we bring Pillar 1 and 2 together into Pillar 3, monetization, driving meaningful and relevant advertising and transactional interactions. As we have discussed previously, the bulk of our current business and backlog is in Pillar 1. And in Q1, our cumulative bookings backlog was $336 million, up 46% year-over-year. That level expanded with more than $10 million of new gross bookings in the quarter with deals across auto, devices and other IoT manufacturers. In this pillar, we continue to extend our offering across new units, while adding more features to existing ones to expand revenue per unit. We can scale with existing customers, and we are constantly adding new ones. In automotive, for example, we saw over 2x growth in units and also realized unit price expansion in Q1. And there are some really exciting new brands in our pipeline. Growing our Pillar 2 voice-enabled services is a key focus area, starting with AI-enabled customer services for restaurants. The demand is real and one advantage here is the pace at which we can scale because of the much shorter sales cycle and activation timeline. I mentioned last quarter how our advanced pipeline of stores was well into the thousands, and we continue to expand that meaningfully in Q1. Through the end of last year, our pipeline largely consisted of small chains and regional brands, generally with less than 50 locations per brand. Since January, we rapidly extended that progress into mid-market and enterprise, who typically have more than 100 locations each. Although these enterprise deals take slightly longer to close, once we onboard one location, it can be nearly immediate for us to scale across the full fleet. And as Keyvan noted, we are also scaling and expanding into more enterprise-focused point-of-sale systems. Already live with Square and Toast, these systems like Olo and Oracle MICROS Simphony extend our offering into hundreds of thousands of new locations. We mentioned expansion into other areas of customer service with new solutions for Smart Answering and Smart Ordering that are vertical-agnostic and can be deployed by any business that is looking to gain an edge on their competition and significantly improve their customer experience. To quantify that further, we are basically expanding the immediate addressable opportunity from roughly 1 million restaurants to tens of millions of customer service opportunities in the U.S. alone. We expect monthly recurring revenue in the several hundred dollars per location, if not more, so you can see how the math can quickly compound and why this is expected to become a very meaningful revenue driver. Let us now get specific on our -- let me now get specific on our financial results for the first quarter. In Q1, we generated $6.7 million in revenue, up 56% year-over-year, driven by strong growth in our product royalties and strength in automotive. Our product royalty revenue increased primarily due to strong customer momentum and expansion with key global brands. Our long-term commitments demonstrate the continued strong partnerships we've developed and the continued share gains we are experiencing. In Q1, our gross margin improved to 71%, up from 59% in the prior year quarter, which was largely driven by the expanding scale of our business, migration of cloud services and increased data center efficiency. Cost of revenue for the quarter was $2 million, up 11% from the prior year Q1. The majority of our cost of revenue includes data center costs supporting our customer production environments. We also continue to migrate some on-premise activities to the cloud, helping us drive further gross margin expansion as we scale the business. Operating expenses saw a step function reduction in Q1 compared to the previous quarter as we executed our announced corporate restructuring program. Restructuring expenses in Q1 were $3.6 million. The full benefit of our cost reductions are expected to be realized as we move into Q2 and beyond, while expected restructuring expenses should be minimal in future quarters. R&D expenses were $14.2 million in Q1, a decrease of 15% year-over-year and 34% sequentially, largely due to the restructuring actions. We delivered this by successfully completing our ambitious language development plans while bringing to market key innovation in both Dynamic Interaction and SoundHound Chat AI in Q1. Notably, our investment in key areas has not slowed as we continue to build out our voice AI platform and leverage our deep patent portfolio. We intend to remain at the forefront of innovation in the rapidly evolving ecosystems of artificial intelligence and machine learning while also helping to develop and scale our cloud offerings and other products and services. In sales and marketing, we also saw a sequential expense reduction. Although year-over-year, we saw an increase from prior Q1 when we hadn't fully yet begun building out this organization. We continue to streamline our focus on digital marketing, lead generation and customer acquisition, both direct and through channel partners. In Q1, sales and marketing expenses were $4.9 million, up 89% year-over-year and down 28% sequentially. With our organizational shifts in 2023, we expect this expense item to benefit from greater focus. G&A expenses were $7.1 million in Q1, down sequentially, though up 78% year-over-year. In the prior year Q1, we were not yet a public company and this year-over-year increase largely reflects investments across the global support functions of finance, legal, facilities and human resources necessary for a public company. Across all operating expenses, noncash employee stock compensation was $6 million in Q1, excluding the expenses associated with restructuring. Our operating loss was $25 million, an improvement of approximately $3.7 million from the prior quarter. Net loss was $26.4 million in Q1, an improvement of approximately $4.3 million from the prior quarter. This led to a net loss per share in Q1 of $0.13, an improvement of $0.02 from the prior quarter. Without the one-time impact of restructuring in Q1, all these metrics would have been improved even more. Adjusted EBITDA, which excludes noncash charges of stock compensation and depreciation and amortization as well as other non-operating activities, including restructuring, was a loss of $14.8 million, which was 21% better than the loss of $18.6 million last quarter and an improvement of 13% year-over-year. Operating cash flow in Q1 was $14.5 million use of cash, improving roughly 30% sequentially and also improved versus the prior year Q1. Now on to the capital structure, where we've made great progress in strengthening our balance sheet. Our cash position at quarter end was $46.3 million. In January, we successfully raised $25 million in preferred equity. Our previously announced committed equity line of credit also became effective, giving us additional access to capital upon which we raised approximately $29 million in Q1. In addition, after quarter end, we raised $100 million of debt financing, which we partially use to pay off our existing debt of approximately $30 million and eliminate the associated principal amortization payments. All-in, our balance sheet has strengthened meaningfully, and we have a fully funded business plan to drive growth and differentiation and provide cushion regardless of how the macroeconomic landscape evolves from here. Our capital position is now a source of strength that we will leverage to drive our business aggressively forward while staying streamlined and delivering on our profitability targets.\ With that, I'll move to guidance. This year we took actions to set the stage for sustained long-term profitable growth. We are pleased with the momentum we have seen to start the year and are encouraged with the momentum we continue to see from customers. Accordingly, we reaffirm our 2023 guidance and continue to expect that revenue will be in the range of $43 million to $50 million. As we noted last quarter, we expect this revenue will build through the year due to seasonality of Pillar 1 and the scaling of Pillar 2 with restaurants and customer services more broadly. We also continue to expect to become adjusted EBITDA positive in Q4 of this year. Before moving to Q&A, I would also like to comment on expectations for other income and expenses in Q2 and impacts from the recent debt refinancing. Given the various transaction-related fees and other charges, we expect roughly $6 million to $6.5 million of expense in the quarter associated with one-time transaction fees, expected ongoing amortization impacts and quarterly interest costs. This is different from the historical level, so I wanted to highlight this expectation. To summarize, we have taken the important steps to set us up for long-term success. We are driving significant market differentiation, delivering on customer demand and catalyzing disruptive innovation with a high velocity. Each quarter on our journey brings its own unique dynamics, yet we are steadily stitching together the foundations for sustainable long-term growth and profitability. Thank you. And we will now move to Q&A.

Thank you. [Operator Instructions]. Our first question will come from the line of Mike Latimore with Northland Capital Markets. Your line is open.

Great. Thanks guys. Congrats on all the progress this quarter. I guess just two basic technology questions. Can you elaborate a little bit more on why SoundHound can prevent these Generative AI hallucinations, just a little bit more detail on why you're differentiated in that regard?

Yes. So we -- there are actually multiple problems that we are able to fix with our Chat AI platform. One is hallucination, where Generative AI language models produce incorrect results, but they sound amazing. So it's very -- makes them more dangerous. The other problem they have is their scale. They don't have access to real-time information and some of the answer that provides used to be correct, but are no longer correct. And the way we saw this is we have -- we even have this Yin-Yang diagram that -- we have two models, one is called CaiLAN, one is called CaiNET. CaiLAN is conversational AI language, CaiNET is conversational AI network. The first one is the software engineering approach. The second one is machine learning approach. And the way we combine them, we are able to get the best of both. We get the strength of machine learning models that can scale really well. We also get the benefit of software engineering approach that doesn't suffer from these unpredictable and undesired consequences. So it's a lot of magic that goes into how we integrate these, but the result is we can reduce the hallucination. We can detect when machine learning is providing an answer that's not correct. We also can detect when we need to go to external APIs or get real-time information from other sources. And also we have domains that don't do well with Generative AI models, things like navigation to addresses and business search that you need these large data structures. So by combining the two, we really get the best of both. And that's a huge value that Chat AI has created. And we have an asset, it's live that people can test. There's a lot more behind that. It's a platform that we are offering to our Pillar 1 customers, the car makers, IoT makers, and we are using the same techniques with our customer service applications.

Got it. Great. That's helpful. With regard to the cost controls, where should we model kind of OpEx broadening? Once it's all into the model, like what would be the absolute amount of OpEx you would have in the quarter?

Well, I guess I'll go back a little bit to what I said, Mike, last time, I had indicated that on an annualized basis, we expected through the corporate restructuring actions that we would see about a $60 million reduction in OpEx. And so if you take kind of last year, it was -- I think it was close to $136 million and kind of chop off $60 million from that. And then this quarter was a little bit of we were -- we executed the action, so there was a sort of partial quarter impact. So I think in Q2, you'll see largely, there's still some international and some other pieces, but by and large, we're through it. And so you'll probably see kind of the full extent of it in Q2 and onwards. And then I don't know if part of your question was where will you see like it is really spread across the line item. So we had impacts across R&D, sales and marketing, G&A, and it was relatively balanced across all of them. So, does that answer your question?

Yes, yes, definitely great. And I guess just last one on the Smart Ordering and Smart Answering. You talked about, obviously, the restaurant vertical. A couple of the incremental verticals you mentioned were kind of more retail like auto shops, I think. Like how broadly is that applicable on customer service? Like I mean can you get into, I don't know insurance and health care as well, which may be a little bit more complicated or is it more kind of that retail focus?

Yes, good question. It's meant to be very broad. The initial rollout will be for targeting smaller businesses. So less on the insurance companies that they -- we can serve those two, but they will require engagement and collaboration. Smart Answering is meant to be completely self-service. So it could be a 1% business or a business with 75 employees and multiple locations, you can discover the service and sign-up on your own and be live on the same day. And we do utilize your website if you have one. If you don't have one that's okay, but if you have a website, you are able to pre-populate a lot of the information from your website. And all you have to do is just examine the information to be extracted and validated. It really could be live -- you could go live on the same day as you discover the feature.

Thank you. One moment for our next question. And that will come from the line of Brett Knoblauch with Cantor Fitzgerald. Your line is open.

Hi, guys. Thanks for taking my question. I guess the first is on the bookings backlog. It kind of increased by the slowest amount or a much slower pace than it has over the most recent quarters. Is this kind of like what you expected going into the quarter? How should we think about it?

Yes, I'll start, Brett. So I think I'll start with, yes, we know that Q1 tends to -- so seasonally, it tends to be a little softer just generally for the business. Part of that is still in the heavy kind of rhythm of the influence of the auto business in our overall business. And so the deals tend to be lumpy, and we had some acceleration of stuff prior year. We know things will happen and some things are still in motion that haven't necessarily closed at the end of Q1. So by and large, in the zone of what we expected. To your highlight, one other thing that we've been highlighting now, I certainly talked about last quarter, as our business shifts and we emphasize the Pillar 2 opportunity, particularly take restaurants as an example, we aren't necessarily reflecting those in bookings. And so we -- as we talked about, as we scale that and we move into Pillar 2, Pillar 3, you'll be hearing more about other type -- recurring type metrics AR and so forth. So there's a little bit of composition of the deals we're focused on. There's a little bit of just normal seasonality and these things can be lumpy. So quite honestly, there's probably a metric better considered on an annualized basis versus even quarterly check-ins. But obviously want to give a milestone as how things are moving. So I'd say overall, kind of in-line, and I'd say this quarter when I look at it, when I look at the top-line perspective, when I look at where we are in movement towards profitability goals that we put out there, I generally would characterize this as an in-line quarter across most of the metrics. Obviously, you can't dial it to the T on anything, but that's how I kind of characterize the whole quarter in general.

Perfect. And I guess just on the full-year outlook, right, it implies quite significant acceleration over the last three quarters. Can you maybe help us out from a modeling perspective and give us some weights that we should expect in terms of when we should expect revenue to fall throughout the remainder of the year?

Yes, I'll go back to something we said last quarter, at least. With revenue, we said similar to 2022 that we expected about one-third of the revenue in the first half, two-thirds in the second half. So I'd say we're kind of marching on that path. In terms of the pathway on profitability, similar to what I answered to Mike's question is we were going through the adjustments on our cost structure in Q1, those have largely been completed. So now entering Q2, by and large, we're sort of at the right level from an operating standpoint. We expect to be able to scale meaningfully with this sort of cost footprint. So as you get into the ramping of revenue, and we also said like we expect revenue to build every quarter, meaning Q2 will be higher than Q3, Q3 will be higher than Q2, Q4 will be higher than Q3. We model that as getting to adjusted EBITDA in Q4 positive.

Got it. And then maybe just some comments on the competitive landscape, right? I think the news kind of this week was Wendy's is using a Google AI to power their drive-thru ordering system. Obviously, this is a space that you guys have been trying to break into and have been quite positive on over the last several quarters. So I guess how are you competing with Google on this front? Do you -- are you -- do you see them when competing for new deals? Do you expect to see them? Should we view this as a U-verse SKU [ph] roll type of market? Just any comments there.

Yes, mostly it's validation of the space because in the last couple of weeks, we've seen a whole bunch of announcements and our visibility is that these were POCs that the restaurant customers saw a benefit in announcing it to show they are innovating in the space that is very important. So net positive and very much validating, in terms of -- our view is that some of the big tech players, they have cloud deals and they -- to win the cloud deals, they bundle voice AI, and it's not really the core part of their offering, but they do lead to some POCs, in terms of the technology competitiveness, the Dynamic Interaction that we really highlight in our drive-thru is very much unmatched like when we presented to our customers, nothing comes close to it. So it's just a matter of education and presenting it to -- putting in front of the brands. And it's rapidly becoming from something that is novel and you have to convince customers that they should pay attention to it to something that they are realizing they needed and is time-sensitive. So it's very much a validation and a positive update in the last few weeks.

Maybe I'll just build on that. There's a couple of points. One is, always got to respect competition, then you got to fight aggressively against it. And we think we should highlight more broadly, and we've talked a little bit about this, just to double click on Keyvan's comments in his prepared remarks and even in response to earlier question, like we have been in this for a while. We have the core technology. We have deep patent portfolio. Generative AI brings a lot to the table here, and we can uniquely sort of bring the best of all the world to improve the technology. And a real key differentiator when you look more broadly at the players that are trying to enter the space in a particularly quick-service restaurant, it's sort of supplemented with humans in the background. So people will claim a order completion rate as a success metric in the high percentages, as you know, 85-plus-percent. The reality is when you look underneath it, they have very low gross margins. We can tell you that they have a lot of humans operating in the background, and it's not apples-to-apples versus ours is fully automated, and we can get that level exceeding human performance with some of the restaurants we've been working with for a long time now really fully automated. And that is good for the restaurant, good for the customer, good for our margin profile. And so there's real differences out there. I think as Keyvan started with, it's very validating of the massive opportunity, the time is now, and we are aggressively going after it. And I will say, just like a lot of things you'll see probably in the broader AI space, there is not a winner-take-all dynamic going on here. There's going to be a lot of players. And if we just took, again, the customer service opportunity, millions of establishments that are going to be looking for these types of services, and we certainly think we've got a great start and are going to aggressively try to keep scaling.