Earnings Call Transcript - API Q2 2021

Operator, Operator

Good day and thank you for standing by and welcome to the Agora Incorporated Second Quarter 2021 Financial Results. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your first speaker today Ms. Fionna Chen. Thank you. Please go ahead.

Fionna Chen, Speaker

Thank you, operator. Good morning everyone and thank you for joining us for Agora's second quarter 2021 earnings conference call. Our earnings results press release, SEC filings, and a replay of today's call can be found on our IR website at investor.agora.io. Joining me today are Tony Zhao, Founder, Chairman, and CEO; Jingbo Wang, CFO. Reconciliations between our GAAP and non-GAAP results can be found in our earnings press release. During this call, we will make forward-looking statements about our future financial performance and other future events and trends. These statements are only predictions that are based on what we believe today and actual results may differ materially. These forward-looking statements are subject to risks, uncertainties, assumptions, and other factors that could affect our financial results and performance of our business and which we discuss in detail in our filings with the SEC including today's earnings press release and the risk factors and other information contained in the final prospectus relating to our initial public offering. Agora remains under no obligation to update any forward-looking statements we may make on today's call. With that, let me turn it over to Tony.

Tony Zhao, CEO

Thanks, Fionna and welcome everyone to our earnings call. Time flies; Agora has been a public company for one year now. Before walking through our Q2 performance and highlights, please let me spend a few moments looking back on Agora's accomplishments over the last year. We have reached the milestone of powering 50 billion minutes of video and audio engagements each month and we have expanded our product portfolio to include an interactive whiteboard, instant messaging, flexible classroom, and many others. More importantly, together with developers on our platform, we are changing the way people work, study, how they play, and lead their lives. Let's start with work. According to a study from Gartner, 82% of business leaders plan to let employees continue to work remotely at least some of the time, while 47% plan to allow employees to do so permanently. This means that modern enterprises must embrace technologies that enable employees to stay productive from anywhere, anytime. In the past year, virtual office, collaboration tools, and virtual events are among the most rapidly growing use cases on our platform. How we play has also evolved. We're seeing a strong convergence of video games and live streaming where the virtual world and real world are combined to create even more immersive experiences. Movies and TV shows are no longer restricted to the living room; it is just as likely to watch a program with your friends across the country as with your family in the living room. Developers are using Agora from the most thorough applications to the most highly regulated and mission-critical use cases. Today, our technology is used by doctors and licensed therapists to provide patients instant access to professional health care services. With Agora's compliant and low latency network, patients and doctors can talk about any sensitive topics anywhere anytime. We are extremely proud that our customers continue to put their trust and confidence in Agora. Now, let's shift to our Q2 performance. I'm pleased to report that our revenue for the second quarter was $42 million, up 25% year-over-year. At the end of June, we had more than 330,000 registered apps on our platform. Our number of active customers reached 2,400, adding 65% year-over-year. Let's take a moment now to discuss the recent regulations in China that will impact K12 academic tutoring services. This new policy requires such services in China to be non-profit and not to be provided on weekends or public holidays among other things. We anticipate the new regulation will have a negative impact on our revenue from the China K12 tutoring sector in the near term. It does not, however, change our long-term vision or business fundamentals. K12 academic tutoring is just one of the many use cases of our technology. In fact, online education is here to stay and will grow in the long term. Our commitment to the global education industry remains unchanged. Agora is dedicated to continue to provide the technology that enables online learning and makes quality education more accessible. To manage the short-term implications, we will be making some adjustments. In China, we will shift our resources previously focused on K12 academic tutoring towards the public school education system and non-traditional academics such as music, art, computer programming, and adult education. We will also continue to strengthen our go-to-market efforts in the US, Europe, and Asia-Pacific, where we are seeing tremendous growth momentum and more diversity in demand. Next, I want to highlight our advancements in product technology and users in Q2. In this quarter, we launched Agora App Builder, which allows developers to create their own video chat and streaming apps with customizable functionalities and UI, without any coding required. Since launch, we have seen very strong adoption from both developers and producers with no technical background. Their positive feedback motivates us to make continued efforts in this local direction to make it even easier for creators to connect with audiences, engage with customers, and drive more business outcomes. On the technology front, we recently announced Agora Silver, our proprietary audio codec using artificial intelligence to optimize quality of experience under poor network conditions compared with traditional audio codecs. Agora Silver achieved superior quality at extremely low bit rates, even compared with leading AI-based audio products such as Google Learn. Agora Silver enjoys lower computational complexity and a more robust noise suppression. With Agora Silver, we will be able to offer developers and end users an immersive experience under challenging network conditions. It is a perfect example of our commitment to cutting-edge innovation at Agora. We also made solid progress on enabling innovative new use cases using our technology. We partnered with Migu, a leading music and digital content platform to develop a one-stop solution for online karaoke. The solution includes both the technology enabling people to sing songs together remotely and a usage-based copyright solution for the soundtrack. We believe social singing will become a key feature in many social apps, just like live streaming did in the past few years. In gaming, we teamed up with HP to power real-time engagement for HP Omen gaming PCs. Our voice, video messaging, and interactive live streaming capabilities are pre-installed on all Omen PCs, which allow gamers to engage during gameplay and turn games into watch parties, enabling players and viewers to share the excitement. We also work with a leading e-commerce platform in Southeast Asia to introduce interactive shopping to their vast user base. In the app, the merchandise is demonstrated by a host through live streaming. The audience can place orders and interact with the host through real-time video or voice chat. Sales conversions have increased significantly as a result of the interactive experience. Now, I want to talk about our developer community. Just about this time last year, we announced our new global start-up program designed to support our early-stage start-ups, no matter where they are and who they are. Now we have over 200 start-ups from six continents and 24 countries participating in our program. We have seen so many innovative ideas that will profoundly change our lifestyle. As our developer base continues to grow rapidly globally, we have been working on our own internal diversity and inclusion programs. I'm proud to see that our employees now support 24 different languages. I also want to take this opportunity to invite you to join me at RTE2021, the annual real-time engagement industry event hosted by Agora. We will showcase exciting announcements featuring many amazing industry leaders and unique RTE innovations that are changing our lifestyles all over the world. The U.S. time zone live event will be on September 1st and 2nd and the China time zone event will be on October 22nd and 23rd followed by October 24th, as long as the program starts to roll. I look forward to seeing you there. Lastly, I would like to thank our developers, customers, and partners for their trust in us. I also want to say thank you to all agents for their hard work and dedication to our customers' success. We will continue to invest in enabling meaningful human connections and creating more real-time engagement possibilities. Now let me turn things over to Jingbo who will review our financial results.

Jingbo Wang, CFO

Thank you. Hello everyone. Let me start by first reviewing financial results for Q2 and then I will discuss our outlook for the full year. Total revenues grew 25% year-over-year and 5% quarter-over-quarter to $42.3 million in the second quarter of 2021. The number of active customers reached more than 2400 excluding those for Easemob, which is up 65% year-over-year. The growth in revenue and active customers was mainly driven by continued adoption of our technology by developers and merchants and growth of new use cases. We reached more than 330,000 registered apps at the end of June excluding those for Easemob, adding over 10,000 per month in the quarter. Additionally, Easemob contributed over $3 million to our top line. As we mentioned in previous earnings calls, to help investors better understand our organic growth by excluding the impact from one-off events such as the complete lockdown in China in the first half of 2020 due to COVID-19, we calculated adjusted total revenues for this period. When comparing to adjusted total revenues in Q2 last year, our total revenues grew 57% year-over-year in this quarter. Our trailing 12 months constant currency dollar-based net expansion rate is 110% excluding Easemob. If we use adjusted total revenues, the adjusted expansion rate would be 140%. Moving to costs and expenses. For my following comments, I will focus on non-GAAP results which exclude share-based compensation expense, acquisition-related expenses, amortization expenses of acquired intangible assets, and income tax related to acquired intangible assets. Non-GAAP gross margin for the second quarter was 61.5%, which was 5.3% lower than Q2 last year and 3.1% higher than Q1 this year. The quarter-over-quarter increase was mainly driven by technical implementations and advancements we have been implementing since the beginning of this year. The year-over-year decrease was mainly due to the continuous growth in new international markets that we are expanding into where infrastructure costs are higher. Non-GAAP R&D expenses were $20.8 million in Q2, up 113% year-over-year as we continue to hire talented employees and strengthen our R&D team as well as the consolidation of Easemob's R&D team. Non-GAAP R&D expenses were 49.2% of total revenues in the quarter compared to 28.8% in Q2 last year. Again, our strategy is to focus on long-term growth opportunities and innovation instead of maximizing short-term profitability. We have been investing significant resources in our R&D capabilities to further strengthen our technology leadership and provide a more diverse portfolio and empower emerging use cases worldwide. Non-GAAP sales and marketing expenses were $9.3 million in Q2, up 72% year-over-year mainly attributable to team expansion and increased advertising and event expenses. Sales and marketing expenses represented 22% of total revenues in the quarter compared to 16% in Q2 last year. Non-GAAP G&A expenses were $5.6 million in Q2, up 140% year-over-year mainly due to team expansion and professional service fees. G&A expenses represented 13.3% of total revenues in the quarter compared to 6.9% in Q2 last year. Non-GAAP operating loss was $9.4 million, translating to a 22.3% non-GAAP operating loss margin for the quarter compared to the operating loss margin of 13.9% in Q1 this year and an operating income margin of 17.4% in Q2 last year. Turning to cash flow, operating cash flow was negative $8.3 million in Q2 compared to positive $7.5 million last year. Free cash flow was negative $11.5 million compared to positive $3.6 million last year. Moving on to the balance sheet, we ended Q2 with $827 million in cash, cash equivalents, and short-term investments compared to $877 million at the end of Q1. The net cash outflow in the quarter was mainly due to negative operating cash flow, capital expenditures, and the consideration paid for the Easemob acquisition and long-term investments. Now turning to guidance. COVID-19 is still an unprecedented variable for our business model where historical experience may not apply. Our guidance on full-year revenues reflects various assumptions that are subject to change based on the uncertainties related to the impact of the COVID-19 pandemic. In addition, as Tony mentioned earlier, we expect that the new regulation on K12 academic tutoring sector will have a negative impact on our revenue in the near-term. With that, for the full year 2021, we have adjusted our previous guidance and now expect total revenues for the full year to be in the range of $159 million to $161 million. In closing, we are proud of the strong performance in Q2 and continue to be confident about the long-term prospects of our business. We'll continue to implement our technical optimization to further reduce infrastructure costs, investing in innovation and R&D capability, and supporting our developers and customers around the world. Thank you to the entire Agora team and everyone attending the call today, and hope you're healthy and safe. Operator, let's open it up for questions.

Operator, Operator

Thank you. We’ll now begin the question-and-answer session. We have multiple questions in queue. Our first telephone question is from the line of Yang Liu from Morgan Stanley. Please ask your question, Yang.

Yang Liu, Analyst

Thanks for the opportunity. I have two questions. The first one is about the overseas revenue. Can management share what is the contribution in the second quarter from the overseas market and what are the growth drivers in the overseas market, especially which are the key regions that contribute growth and what are the key use cases that drive the volume growth? That's the first question. And the second one is on the gross margin. We see a pretty good quarter-on-quarter gross margin turnaround. I guess Jingbo mentioned several times that the optimization on the infrastructure side contributed to that. Could you please share about the future outlook? And is this trend sustainable going into the second half, especially given part of the K12 related revenue will be gone due to the regulation issue? Is this infrastructure level optimization able to continue to help on the margin? Thank you.

Jingbo Wang, CFO

Sure. So I'll take the first part of the first question. Revenue from the US and the rest of the world market in the quarter contributed about 27% of the total revenues, which is similar to the ratio in Q1. However, I want to highlight that in this quarter, we fully consolidated the results from Easemob, where the revenue is 100% in China. So if we exclude this market, the actual ratio of revenue from the US and the rest of the world actually continues to increase. And Tony can you talk about the revenue drivers?

Tony Zhao, CEO

Right. So we are actually, as always, very excited about the opportunity from the US and the rest of the world market. I think two days ago, dating was, two, three years ago, our largest use case by revenue in the US and rest of the world market. Today, we have many more use cases, many of which emerged in the past 12 to 18 months, and we have a much more balanced revenue mix now. Our fast-growing use cases can be roughly grouped under three themes. The first one is what we call the future of work. Obviously the pandemic has permanently changed how people work, collaborate, and study. We now have several large future event customers that hold all kinds of events from free shows to celebrity gym classes through our platform. We’re happy to see that they enjoy the benefit of our quality of experience advantage brought by our services. Recently, there's also a leading collaborative design platform that has integrated our voice and chat feature to its users so that they can have a live discussion while working on design projects. We are also working with some virtual office platforms, such as Loop and Virbela, to define how distributed teams will work together in the future. We recently also paired with a global education giant, originally from the China market, to teach foreign languages to adults and children around the world. And the list goes on and on. I think the future of work is definitely not just a one-size-fits-all video conferencing solution. With Agora, we can have video, voice, and all the workflow tools deeply integrated, creating a more immersive and effective remote working experience. The second thing is the future of media. In the past decade, we have all witnessed the transformation from TV and radio stations to Netflix and Podcast. I think the next phase of the evolution in media is real-time interactivity. Audio live chat, for example, has created a brand and more engaging experience compared with traditional podcasts. We now have several large customers who are working with us to either launch a standalone live cast app or introduce live cast to their existing apps. Another important direction is interactive TV. Currently, we are designing with several interactive TV providers to bring audience interactivity to game shows similar to Who Wants to Be a Millionaire. Here, the audience can answer questions in real time on their mobile phones and even have the chance of jumping on stage to participate in the show itself. We're also working with sports betting companies to offer real-time betting alongside video live streaming of the match. Here, the key to make sure the video latency is both low and uniform across all users, so that they all have a fair chance of winning the bets. The third theme is future of gaming. We see a clear trend of convergence of games and live streaming. More and more games are adding live streaming functions so that players can interact and share their game experiences with others. On the other hand, live streaming platforms are adding gaming features to live streaming sessions to boost interactivity between the host and audience. In fact, I think the convergence of games and live streaming is an important step towards creating a new networks. Our technology is perfectly positioned to help developers make this happen. In short, I think you can see our future growth through those three lanes. There was a question about gross margin, right?

Jingbo Wang, CFO

So in terms of the gross margin, yes. The sequential improvement in GP margin was mainly reflected by our efforts in optimizing the technical architecture and also utilization rates. This is a continuous effort. So we do believe we will be able to make additional savings in the future gradually. However, there are several factors at play. You mentioned the education policy change. It's true that the change will likely reduce traffic coming from the sector, especially during weekends and summer winter vacations. Typically, this type of reduction in traffic from one sector would cause pressure on the GP margin, but it will reduce bandwidth utilization rate. But in this case, it's actually a little more complex. If the education traffic is more concentrated during weekdays and other traffic, like social gaming, is more concentrated on weekends, actually the utilization rate might potentially even improve. So if we take all these factors into consideration, we actually expect that we are working to ensure that we can have a relatively stable GP margin in the next few quarters.

Yang Liu, Analyst

Thank you.

Operator, Operator

Our next telephone question is from Emerson Chan from BofA Securities. Please ask your question, Emerson.

Emerson Chan, Analyst

Hi. Thank you, management. I have three questions. Firstly, for our new guidance. What revenue assumptions do we have on both academic and non-academic in total in the second half? And what is the revenue impact on education we have already seen in the second quarter? And secondly, I just want to get some color on the growth rate for the non-education vertical in China in the second quarter. And what were the key growth drivers behind, as we may see tight regulation on media content? Do we think our non-education sector in China will slow down in the future? And my last question is regarding our active customers, where we see net adds slow down quarter-on-quarter in the second quarter. So I just wonder what are the key reasons behind this, whether it was due to the education regulation, non-education vertical or anything else? Thank you.

Jingbo Wang, CFO

Sure. I guess the first two questions are kind of related. So maybe I will start by sharing more information on the education situation. So in Q2, K12 academic tutoring contributed about 25% of total revenues. The actual revenue we saw in Q2 was already below our initial estimate before the policy since the education companies already started to cut back on advertising spending and their expansion student sign-ups. So there was already some impact in Q2. However, we expect to see further impact in Q3 because some local governments have already started to enforce a new policy in August. We expect the most impact will be seen in Q4 at which point most local governments will really enforce all the policies. By the end of Q4, we will see a new norm and what people might consider a new clear base. But at this point, it's really hard to estimate what that new base will be given uncertainties around the interpretation and enforcement of the policy. So when we provide guidance we try to make a balanced estimate, obviously, there are uncertainties involved. Ex-K12 education in China, we do not expect a slowdown. We actually see quite a few exciting opportunities. For example, Tony mentioned social singing; we are actually working with several customers adding this feature into their apps. We do believe this, like live streaming, is going to be both an opportunity for standalone apps and also an opportunity to become a standard feature in many social apps. So in China, I think the broader mobile Internet penetration is already very high; there's not much room for user growth. However, the penetration of real-time engagement within apps still has a lot of room to grow. For example, a user might spend 60 minutes on mobile per day, but most of the minutes are used for one-way content consumption, and only one or two minutes are used for user interaction through video or voice. So here this penetration is driven by new ways of interaction. The same is one way. And there are other possibilities like the convergence of games and live streaming. So we do not expect any slowdown for the other sectors. On the active customers, we have seen the growth in this quarter is still pretty healthy, as we added about 120 active customers quarter-on-quarter because we define customers based on the last twelve months. So you might see a sharper growth rate several quarters back earlier, and that's because during the peak of the pandemic, obviously there were more emergency use cases, emergency sign-ups. I actually think the recent growth in customers is still pretty healthy.

Emerson Chan, Analyst

Thank you.

Operator, Operator

Our next telephone question comes from the line of Vincent Yu from Needham & Company. Please ask your question, Vincent.

Vincent Yu, Analyst

Thank you management. I have two questions also quite about regulation. The first one is in terms of live streaming, we do see there's discussion surrounding potential more regulations on the live streaming side. What's our view towards that? Yes. And what's the worst scenario we think it could be? The second question is actually also about education. But in the policy, it says that the government is encouraging public schools to provide platforms or free classes online to interact with the students. So do we think we can take some share on that front? Thank you.

Tony Zhao, CEO

Okay. So on the live streaming side, we are actually not aware of new regulations coming out on live streaming. In fact, the regulatory environment in China has been very strict for social and live streaming apps for quite some time, which is actually a good thing as it makes the whole industry healthier. Now if you are actually talking about some activities or voices on gaming, there might be some regulation on gaming for primary school students, some public discussions. But we don't expect this to have a significant impact on our revenue. We don't have a bigger base on that. Did you have a second part to your question?

Vincent Yu, Analyst

Yes. The same question is about regulation. You mentioned encouraging local schools or public schools to provide online classes to students for free. But do you think we could gain some government contracts on that front, or we don't see it yet?

Tony Zhao, CEO

Yes, that's often where not just us but a lot of education institutions or companies are also looking at those directions. As I think we mentioned briefly including public education, adult education, and some non-academic tutoring services like music and art and even overseas markets for some Chinese education companies. All the directions they are trying to go. And I might want to mention that non-profit education is not necessarily free education. There are many such practices in the industry in the past already. We will definitely participate in those trends and are working actively with several partners on such experiments.

Operator, Operator

And our next question is from Bing Duan from Nomura. Please ask your question, Bing.

Bing Duan, Analyst

Hi. Thank you management for giving me a chance to ask questions. I also have two questions. First about the net dollar retention rate. So this quarter, it has been moderated to around 110. So could you elaborate more on the reasons behind that? And how do you see the trend in the next few quarters? The second question is about some new emerging use cases. For example, the e-shopping live streaming use cases cooperated with an e-commerce company in Southeast Asia. I just wonder how you see the trend of the volume and revenue growth in the future in this client or, in a broader sense, for the e-commerce sector in overseas markets? Thank you.

Jingbo Wang, CFO

Sure. So in terms of the expansion rate, we define expansion rate based on the last twelve months. So we look at the active customers from the previous twelve months. We focus on the same cohort of customers and see comparative revenue from that period to the most recent twelve months. If you think about this calculation for this quarter, the most recent twelve months would be July last year to June this year, while the previous twelve months would be July 2019 to June 2020. Hence, the twenty-four to thirteen-month period would include a peak of the pandemic in China during the total lockdown, where the revenue base was abnormally high and included a lot of the one-off revenue contributions. The most recent twelve months is based on a normal working base. That's why direct comparisons would lead to a low expansion rate. We actually don't think that expansion rate is very meaningful. That's why we also provided the adjusted expansion rate, where we remove the one-off revenue from the previous twenty-four to thirteen-month period. If we remove that, the expansion rate would be 140%, which is more meaningful. We do expect that if we go to the next quarter, the unadjusted expansion rate will remain at a lower level, while the adjusted expansion rate will be more meaningful. On the second question regarding e-commerce, actually what we talked about is, the interactive e-commerce, live streaming e-commerce is already quite prevalent in China. The trend really started about one year ago, 1.5 years ago. Outside China, it's less prevalent. However, we do think it's definitely going in the direction of future trends. We are working with several customers, but as with many things, it takes time for user behavior and habits to change and evolve. We also see the opportunity right now with several customers using traditional CDN technology toward the live streaming broadcast to hundreds of users. What we want to do is persuade customers to use our technology for both the interactive part and the audience part towards the whole live streaming broadcast. We have seen some early success there. If that can become the norm, their revenue potential is much more significant since obviously we have more audience than hosts and then the participating audience. That's the opportunity we see for the future.

Bing Duan, Analyst

Thank you very much.

Operator, Operator

Our next telephone question comes from John Wang from Macquarie. Please ask your question, John.

John Wang, Analyst

Hi. Thank you, management for giving me a chance to ask questions. So, firstly, we have seen the Chinese government is becoming more and more stringent on data securities. What would we expect as the worst scenarios? And do we have any contingency plans for that? Secondly, also on DBNR, can you give us more colors on this in the next couple of quarters? And any colors on differences between the China and non-China clients and on different vertical clients? Thanks.

Tony Zhao, CEO

Okay. About the regulation from the Chinese government. I think a lot of the policy or regulation seems to be rolling out all of a sudden. But if you look into the direction of certain trends, there are traces back from long-term discussions around how they're going to manage these areas of services. It's not just about education; it could be also housing and medical services. I think a lot of those are still in the direction of trying to create a healthier economic environment overall, and it's not against any new technology kind of being leveraged to create a more accessible or better services in all industries where we are actually in that direction. For example, on the execution side, on one side, the commercial academic tutoring service is right now being heavily regulated, but before that, you could see even on government policy side, they are promoting the so-called street class initiative to leverage online education technologies or tools to make sure that good content by elite teachers can be shared across the country. So we think that overall the regulation would not significantly reduce or limit our future growth. But in the near term, it will impact which customer or use case will be more sustainable for our growth.

Jingbo Wang, CFO

On data security, actually, we don't think that will have a significant impact on us. We've always been very careful regarding user data. We have always had a policy that we call minimal data collection. We intentionally do not try to collect any more data than is absolutely necessary. When we work with a customer, we work with the app to connect to its users; active users are anonymous; we don’t know who they are. We only see their IP addresses, which is required for us to establish connections, and nothing else. We don’t collect data. We have spent a lot of time and resources working with consultants to enhance our overall data security and privacy practices. In fact, we are fully GDPR-compliant and hold many other certifications necessary for operating in Europe and the US. If you compare us with many companies in China, we are probably the most advanced in terms of security and data protection. So actually, if anything, I think this is going to be advantageous for us as we are already very advanced in compliance.

Tony Zhao, CEO

So on DBNR, as I mentioned, we think if we do not adjust the one-off revenue spike in Q1 and Q2 last year, you will continue to see a relatively low level of DBNR nationwide. However, if you just remove that one-off revenue contribution, you will see more meaningful numbers. We have always guided around 130% as our normal DBNR for this business. In terms of China versus US rest of the world, and verticals obviously within the past 18 months, the US and rest of the world business has been particularly strong, so the numbers there would look stronger.

John Wang, Analyst

Great. Thanks.

Operator, Operator

Pardon me. There are no further questions at this time. I would like to hand the call back to the speakers for closing remarks. Please go ahead.

Fionna Chen, Speaker

Thank you, operator, and thank you everyone for attending this meeting today. Our presentation and the remarks from this call will be uploaded on our IR website. Please feel free to access that for further information, and don't hesitate to contact us if you have any more questions. Thank you all.

Jingbo Wang, CFO

Thank you.

Tony Zhao, CEO

Thank you.

Operator, Operator

Thank you all. You may all disconnect. Have a great day. Goodbye.