Earnings Call Transcript - API Q3 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to Agora, Inc. Third Quarter 2023 Financial Results Conference Call. Please be advised that today's conference is being recorded. The company's earnings results press release, earnings presentations, SEC filings and a replay of today's call can be found on its IR website at investor.agora.io. Joining me today are Tony Zhao, Founder, Chairman and CEO; Jingbo Wang, the company's CFO. Reconciliations between the company's GAAP and non-GAAP results can be found in its earnings press release. During this call, the company will make forward-looking statements about its future financial performance and other future events and trends. These statements are only predictions that are based on the company's belief today, and actual results may differ materially. These forward-looking statements are subject to risks uncertainties, assumptions and other factors that could affect the company's financial results and its performance of its business, and which the company has discussed in detail in its filings and SEC, including today's earnings press release and the risk factors of other information contained in the final prospectus relating to its initial public offering. Agora, Inc. has no obligation to update any forward-looking statements the company may take on today's call. With that, let me turn it over to Tony. Hi, Tony.

Tony Zhao, CEO

Thanks, operator, and welcome, everyone, to our earnings call. In the third quarter, our revenue was $15.3 million for Agora, flat compared to last quarter at RMB 141 million for Shengwang, an increase of 7.4% quarter-over-quarter. As of the end of this quarter, we have more than 1,600 active customers for Agora and more than 4,000 for Shengwang, an increase of 26% and 6%, respectively, compared to 1 year ago. Now moving on to our business, product and technology updates for the quarter. Let's start with Agora. We recently announced the general availability of a video-based solution to power live shopping experiences. In recent years, live shopping has disrupted and transformed the entire e-commerce market in China. We believe that the U.S. and other developed markets will soon catch up and embrace live shopping as the next big trend. According to McKinsey, live shopping could account for 20% of our e-commerce sales by 2026 and the U.S. live shopping market is estimated to be worth $35 billion by 2024. We're also proud to mention that Agora was highlighted as a leading vendor in Gartner's recent market guide for live commerce in retail. With Agora, brands, marketplaces, and platforms can now seize the live shopping opportunity with ease. For example, we recently helped CommentSold, the leading fashion live shopping platform for retailers, introduce a new functionality that allows sellers to invite external participants into their shows simply by sending them a link or QR code. Sellers can easily and professionally host, invite celebrities, influencers, or VIP customers to join their live shopping session video to provide more engaging content and boost conversion. This quarter, we also partnered with the Sandbox, a leading decentralized gaming virtual world, to promote real-time engagement and social interactions within the metaverse through voice, video, and chat. The Sandbox chose Agora because of our comprehensive product stack, which can seamlessly integrate 3D spatial audio, persistent text chat, and interactive live streaming functionalities at scale. As a result, players' ability to connect, collaborate and form meaningful communities in the metaverse is significantly enhanced. Moving on to Shengwang. We recently launched our AIGC RTE SDK, a real-time engagement solution connecting human users with large language models. So far, people have largely interacted with AI models in text format. Only recently have companies such as OpenAI beta launched their direct voice conversation between human users and AI models. However, there is certainly a significant delay of 6 to 7 seconds or more to receive a simple voice response. Our solution has been designed to tackle the latency issue so that users can hear the response within 2 seconds. This near real-time response mimics the natural pause expected in human-to-human conversations and, therefore, provides a much more engaging and near real experience for users. Our AIGC RTE SDK also comes with great flexibility; developers can easily create their applications with the freedom to choose from a wide range of large language models, speech-to-text engines, and synthetic voices to fit their unique use case. A video demo of our AIGC RTE solution can be found in our earnings presentation with more details on its features and capabilities. Please also feel free to download the demo application and try it yourself. Next, let's move to the real-world factories to see how we assist BMW in their digital transformation journey. Historically, when local engineers needed technical support from the specialists at BMW headquarters in Germany, they had to wait at least 24 hours before the specialist could arrive on site, which could impact manufacturing timelines and even cause delays in delivery. Our solution enables the remote specialist at BMW headquarters to remotely inspect even the smallest detail with HD video and low latency. In addition, when the specialist makes inquiries or provides instructions, local engineers can see exactly where the specialist is marking with the help of AR devices. This solution demonstrates our commitment to becoming a trusted partner for large enterprises in their digital transformation initiatives. Last month, we held our RTE conference for the ninth consecutive year, where we discussed the role artificial intelligence plays in real-time engagements. We have been leveraging AI to enhance the quality of experience in real-time engagement for a long time. We developed AI-powered real-time on-device noise suppression and echo cancellation algorithms that significantly improve audio quality. On the video front, our AI-based real-time on-device algorithms, such as super resolution, perceptual video coding, object segmentation, adaptive coding, and video quality assessments enable us to deliver optimal video quality and viewing experience up to 4K resolution. Many of our customers worldwide have integrated our latest SDKs with these AI technologies, and more are in the process of upgrading. With our constant pursuit of more efficient AI-powered SDKs to overcome the limits of device and network infrastructures, we have substantially reduced the barrier to high-quality real-time engagement, meaning that people around the world, even those without the latest smartphones or access to high-speed internet, can now enjoy a wide range of real-time engagement use cases, just like how they have access to basic utilities such as clean water and electricity. With billions of smartphones and devices powered by our SDK with AI-driven capabilities, we are making solid progress to realize our mission of making real-time engagement ubiquitous and allowing everyone to interact with anyone, anytime, and anywhere. We have also closely followed the development of large language models and generative AI around the world. As mentioned earlier, our AIGC RTE solution enables developers to create AI-powered characters for voice conversations with users. We have been working closely with some customers and expect to see them launch their innovative use cases soon, such as AI companions, personal assistants, social deduction games with AI players, and AI tutors to help users learn foreign languages. As large language models continue to advance in their ability to process and generate multimodal information, substantial amounts of data in video and audio format will need to be transmitted between human users and AI models. The volume of such data will one day surpass today's human-to-human traffic, and we are uniquely positioned to become the critical infrastructure that enables human users and AI models to interact with each other through video and audio. Before concluding my prepared remarks, I would also like to announce a change in our Board of Directors. Mr. Tuck Lye Koh has tendered his voluntary resignation due to personal reasons. Tuck has been working with us since our inception a decade ago, first as an investor, then as a director since 2018. I would like to sincerely thank Tuck for his dedicated service and invaluable advice to our Board. Mr. Shawn Zhong, currently our Chief Technology Officer and Chief Scientist, has been appointed as a director. I would like to warmly welcome Shawn to our Board. I am confident that Shawn's insights and expertise will help the board and the company stay at the forefront of real-time engagement technology and create long-term value for our shareholders. With that, let me turn things over to Jingbo, who will review our financial results.

Jingbo Wang, CFO

Thank you, Tony. Hello, everyone. Let me start by first reviewing financial results for the third quarter, and then I will discuss the outlook for the fourth quarter of 2023. Total revenues were $35 million in the third quarter of 2023, an increase of 2.9% quarter-over-quarter and a decrease of 14.6% year-over-year. Agora revenues were $15.3 million in the third quarter, flat compared to last quarter and decreased by 8.9% year-over-year. The year-over-year decrease was primarily due to reduced usage and increased pricing sensitivity from customers in emerging markets due to a challenging macroeconomic environment and tightening financing conditions, starting from the second half of last year. So on revenues, we're RMB 141.2 million in the third quarter, an increase of 7.4% quarter-over-quarter and a decrease of 9.2% year-over-year, excluding revenues from the disposed CIC business. The quarter-over-quarter increase was primarily due to an increase in revenues from digital transformation customers or large enterprises. This is an area where we have seen strong revenue growth in the past two years. Going forward, we believe the digital transformation market will become an increasingly important revenue and profit contributor for the Shengwang business. The year-over-year decrease was primarily due to slowing general economic conditions and fast-evolving regulations in certain downstream markets. The dollar-based net retention rate is 98% for Agora and 89% for Shengwang, excluding revenues from discontinued business. Moving on to cost and expenses. For my following comments, I will focus on non-GAAP adjusted financial measures, which exclude share-based compensation expenses, acquisition-related expenses, financing-related expenses, amortization expenses of acquired intangible assets, income tax related to acquired intangible assets, impairment of goodwill, depreciation of property and equipment, and amortization of land use rights. Adjusted gross margin for the third quarter was 66.9%, 3.3% higher than Q3 2022, mainly due to the change in product mix and the implementation of technical and infrastructure optimization. As mentioned in previous earnings calls, we've restructured and reduced our global workforce in Q4 last year, and we have continued to implement effective expense controls. As a result, adjusted R&D expenses were $15.7 million in Q3, a decrease of 36.4% year-over-year. Adjusted R&D expenses represented 44.8% of total revenues in the quarter compared to 60.2% in Q3 last year. Adjusted sales and marketing expenses were $6.6 million in Q3, decreased by 48.8% year-over-year. Sales and marketing expenses represented 18.9% of total revenue in the quarter compared to 31.5% in Q3 last year. Adjusted G&A expenses were $6.2 million in Q3, decreased by 15.1% year-over-year. G&A expenses represented 17.6% of total revenues in the quarter compared to 17.7% in Q3 last year. Adjusted EBITDA was negative $4.4 million, translating to a 12.7% adjusted EBITDA loss margin in the fourth quarter, significantly lower than the gross margin of 40% in Q3 last year. Investment loss was $13.4 million in Q3, mainly due to the fair value changes in equity investment of $7 million and losses on investments in certain private companies of $6.3 million. The non-GAAP net loss, excluding investment loss, was $2.2 million in Q3, translating to a 6.3% net loss margin for the quarter compared to a non-GAAP net loss margin of 42.9% in Q3 last year and 19.4% in Q2 this year. Now turning to cash flow. Operating cash flow was negative $3 million in Q3 compared to negative $8.8 million last year. Free cash flow was negative $3.2 million compared to negative $9.9 million last year. Moving on to the balance sheet. We ended Q3 with $373.4 million in cash, cash equivalents, bank deposits, and financial products issued by banks. The net cash outflow in the quarter was mainly due to free cash flow of negative $3.2 million and share repurchase of $12.5 million. Thanks to the Board, which approved our share repurchase program in February 2022. As of September 30, 2023, we have returned approximately $94.3 million to shareholders through share repurchase, demonstrating the Board's commitment to safeguarding shareholder value and its confidence in the long-term prospects of the company. As of September 30, 2023, the company had approximately 94.3 million ADS outstanding, reflecting a 16% reduction in total shares outstanding compared to January 31, 2022, before the share repurchase program started. So far, we have completed 47% of a $200 million share repurchase program, which will expire in February 2024, and we intend to continue to undertake meaningful capital return to our shareholders. Now turning to guidance. For the fourth quarter of 2023, we currently expect total revenues to be between $35.5 million and $37.5 million. This forecast reflects our current and preliminary view of the market and operational conditions, which are subject to change. In closing, we are very proud of our execution in this quarter, especially the extensive improvement in profitability. We'll stick to our strategy and be laser focused on driving revenues and improving efficiency. For the long run, as Tony just mentioned, we are excited to see emerging AIGC use cases, and we are well prepared to help developers combine the power of generative AI and real-time engagement. Thank you to both Agora and Shengwang teams for their hard work and to our investors for your trust. Thank you, everyone, for attending the call today. Operator, let's open it up for questions.

Operator, Operator

First is from Tom Tang from Morgan Stanley.

Tom Tang, Analyst

I have questions. This is Tom from Morgan Stanley. So I have 2 questions. The first one is regarding the 2024 outlook and would like to have a breakdown between Agora and Shengwang business? And the second question is regarding the competitive landscape in both China and overseas.

Tony Zhao, CEO

Sure. The status for both Shengwang and Agora for our growth side, I think the growth of the global market overall, I'm optimistic about demand in the midterm to long-term. I think one big factor is the pandemic that really changed consumer behaviors. Before the pandemic, the only scenario where people used real-time audio-video was basically web conferencing. The U.S. market was not that used to or familiar with all other use cases like co-working, experiences, etc. Now after the pandemic, although in some of the use cases, the volume decreased, consumers are more adapted to all types of real-time engagement activities online, such as shopping with live conversations and interacting with live sessions online, or co-working or watch parties. I think overall, these changes in consumer behavior can help us to see significant growth in both use cases and volume. Meanwhile, the macro environment is still challenging, but it affects all companies operating in this market. In fact, we see some small competitors start to run into financial difficulties. For 2024, our goal is to stabilize our existing business and grow into new regions and new use cases. In China market, a lot of macro and regulatory headwinds, as you probably already know, but usage of our platform continues to grow. Our market share in new adoptions also increased nearly 20% this year. Our digital transformation business serving large enterprises also grew more than 50% this year. For 2024, we expect our digital transformation business to continue to grow, and our goal for the Internet business is to further gain market share. Regarding the demand and pricing for Agora's market, our number of customers continues to grow at about 25%, as I mentioned earlier. Also, we see more use cases beginning to emerge into growth mode, such as live shopping. I also mentioned that the change in consumer behavior gives us hope that there will be more growth potential in both use cases and volume. Overall, the challenging environment is still there and impacts operations in the near term, but there is a lot of potential in the medium- to long-term timeframe. Pricing-wise, there is more pressure in emerging markets, but pricing has been healthy and stable in developed markets. In China, overall, demand is stable from Internet customers, with some bright spots such as online karaoke and premium broadcasting streaming products. We see strong demand from the digital transformation side, as I mentioned. Pricing in the Internet sector generally dropped about 10% each year, but our gross margin remains healthy. Pricing in digital transformation is also more attractive in this market.

Operator, Operator

Next, we have Daley Li from BofA Securities.

Daley Li, Analyst

I have got one question about the AI. You mentioned there's more application scenarios for the AI like AI assistant, AI tutor, etc. When do you think the AI can really have a more meaningful revenue contribution to our business? Or in which application do you think could have the potential to drive our business growth in the future?

Tony Zhao, CEO

Yes, you're right. As I also talked about, there are many potentials in all sorts of use cases like AI companions, AI game players, etc. However, as I mentioned, we rolled out this AIGC RTE SDK module in the last few months. We do have an optimistic view of those potentials, just in a very basic concept, there's going to be much more real-time audio/video traffic among not just humans but between humans and AI models. That's for the long-term future. However, the development is still underway. I think there's still a lot to figure out for large language models to be able to truly act as human-like personas like the AI companions or players in certain games. That's where we work hard with our customers and partners together to try to bring it to life, and I don't want to overestimate the near-term growth. This is really at the stage where we and our customers and partners are trying to validate and break through into each and every use case in the next few quarters.

Operator, Operator

There are no further questions. Thank you, everyone, for joining this call today. As a reminder, the recording from the earnings release will be available on the company's website at investor.agora.io. If you have any questions, please feel free to email the company. Thank you, and have a great day.

Tony Zhao, CEO

Thank you.