Earnings Call Transcript - API Q1 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Agora, Inc. First Quarter 2023 Financial Results Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to the IR Director, Ms. Fionna Chen. Please go ahead, ma'am.

Fionna Chen, IR Director

Thank you, operator. Good morning and evening, everyone. Thank you for joining us for Agora, Inc.'s first quarter 2023 earnings conference call. Our earnings results press release, earnings presentation and an explanatory note on certain reporting and disclosure adjustments, 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, our 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 the performance of our business and which we discussed 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, Inc. 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. Hi, Tony.

Tony Zhao, CEO

Thanks, Fionna, and welcome, everyone, to our earnings call. Before diving into our operational results for the quarter, I would first like to make a few remarks regarding recent changes in the organizational restructure of our company. Since our inception 9 years ago, we have mostly operated under the Agora brand globally to better meet the requirements of our customers and compete more effectively in the unique market we serve. We will now operate 2 independent divisions under the same holding company. Our Agora division will focus on our business in the U.S. and international markets, and our Shengwang division will focus on our business in the China market. Agora and Shengwang will each be run by a local management team and adopt local standards and best practices. We have appointed Stanley Wei as Chief Operating Officer of Agora and Robbin Liu as Chief Operating Officer of Shengwang. We believe this strategic reorganization will allow us to optimally focus our resources on the specific needs and the priorities of each business. Agora will focus on acceleration of growth and on gaining market share in the U.S. and international markets, leveraging our leading technology and competitive product offerings. Shengwang will focus on enhancing our quality of experience advantage and improving the ease of adoption of our products, further strengthening our competitive position in the China market. By empowering the local management team of each division, we will be able to respond more quickly to the needs of our customers and become more agile as new opportunities emerge. From this quarter onwards, we will report our revenue and operating metrics separately for Agora and Shengwang to help investors better understand the dynamics and our operational results in each of these markets. Our revenue for the first quarter was $15.1 million for Agora, up 10% year-over-year; and $21.3 million for Shengwang, down 14% year-over-year. Agora's revenue growth was primarily due to business expansion and usage growth in U.S. and international markets. Shengwang's decrease in revenue was primarily due to the appreciation of U.S. dollar, our disposal of Easemob's customer engagement cloud business and decrease in usage from K12 academic tutoring customers. After adjusting for these factors, Shengwang's revenue would have increased by 3% compared to the same quarter last year. As of the end of this quarter, we have nearly 1,500 active customers for Agora and nearly 4,000 for Shengwang, an increase of 31% and 2%, respectively, compared to one year ago. Now moving on to our product and technology updates. First, starting with Agora. The Flexible Classroom, our low-code PaaS solution designed for building scalable and customizable online classrooms, has continued to gain momentum in the U.S. and the global market as the demand for online learning continues to grow. Recently, the Flexible Classroom was named a finalist by The EdTech Awards in the e-learning, blended, flipped solution or remote solution category. Previously, we mentioned our partnership with HTC to accelerate the adoption of real-time engagement in VR applications. In HTC's VIVE ecosystem, developers use our Video SDK to power real-time collaboration between end users within virtual environments. Recently, we were recognized as a Webby Awards honoree under the category of Metaverse, Immersive & Virtual Best Real-time Experience for how our technology is used in HTC's VIVE Sync VR ecosystem. To further increase the value of our premium and enterprise support package for our customers, we have added integrations with Okta and Datadog. The Okta integration enables customers to manage team members' access to Agora Console through Okta identity management tools. The Datadog integration with Agora Analytics enables customers to push analytics data, current usage, quality and performance directly to the Datadog platform for analysis and visualization. Moving on to Shengwang; we recently upgraded our real-time karaoke product. When this solution was first launched in 2021, it could accommodate 2 users singing together at the same time. If a third user wanted to join, one of the 2 current users would have to give up the microphone. This limitation was mainly due to the technology challenge at the time of mixing multiple real-time soundtracks in a highly synchronous manner and delivering output to all users with low latency. With our latest version, up to 8 users can now sing together, which unlocks a wide range of new features for our customers' applications. For example, all users in the virtual karaoke room can now participate in a singing battle or take random turns singing part of songs together. Powered by our upgraded product, our customers can now replicate an in-person karaoke experience within their application. Next, I would like to discuss the combination of generative AI and real-time engagement and the enormous opportunity this combination holds for the future. Since the end of last year, the world has been captivated by the latest advancements in large language models and generative AI. People widely believe that generative AI, despite being in its early stage, will drive significant paradigm shifts in many industries, and real-time engagement is no exception. Generative AI can empower customers to dramatically enhance end-user experience in their applications or create new use cases that were previously impossible. Let's look at some examples. The advent of powerful large language models has significantly improved the performance of chatbots in text format, as can be seen in the growing popularity of ChatGPT and AI-powered search engines. However, this is only the beginning. As AI models continue to evolve and gain more powerful multimodal capabilities, they will become more adept at processing voice and video feeds and generating responses in real time. Using IoT hardware as input/output devices, people will have an all-powerful, humanlike AI body that can provide information, carry out tasks or engage in casual chats all through voice and video. Education is another industry where people have strong hopes that generative AI can help revolutionize experiences. By analyzing student data, AI-powered tutors can generate personalized learning plans and deliver learning content in an interactive manner with everything tailored to best match a student's learning progress, patterns, and real-time feedback. In addition, AI tutoring can also provide affordable and tailored educational opportunities to those who previously did not have access to quality education. There is also huge potential for generative AI to disrupt the social, entertainment, and gaming industries. A virtual matchmaker can do the job of making the initial introduction and facilitating conversations just as well as a real person in the dating application. If you need to leave an interactive session for a short while or are being disrupted by network connection, your digital twin can take over and continue the conversation. When you come back, a summary can be immediately available for you to catch up. For online social gaming, it will become almost impossible to tell if your teammates or opponents are real players or AI-controlled non-player characters. Looking at the examples above and many others, we see something in common. Generative AI can significantly expand the scope and opportunity of real-time engagement. Previously, real-time engagement largely took place among groups of people. With the help of large language models, real-time engagement can now occur among people, digital twins of people, and fully virtual, AI-based characters, opening the door to a much broader range of possible use cases. In addition, with greatly enhanced user experience, real-time engagement will become more intelligent, immersive, and enjoyable. This trend will likely increase the overall usage of real-time engagement solutions multiple times and bring more business opportunities. We have been working closely with our customers to create pilot applications in certain verticals, and we will continue to monitor the latest developments while assisting our customers in utilizing generative AI in their real-time engagement use cases. Before concluding my prepared remarks, I want to thank both the Agora and Shengwang teams for their hard work during this transitional period. I believe this strategic reorganization will sharpen our ability and strengthen our position in both the global and China markets and most importantly, allow us to serve developers and customers in a more agile and efficient way. 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 discussing certain reporting and disclosure adjustments in our financial results. I will review financial results for the first quarter and outlook for the second quarter of 2023. Following our recent reorganization, Agora, Inc. is now the holding company of 2 independent businesses, Agora and Shengwang, which will operate under their own unique brands and distinct legal entities and will be run by separate local management teams. Beginning from the first quarter of 2023, we will report revenues separately for Agora and Shengwang based on the legal entities with which customers enter into contracts. This differs from our previous practice, which was to separately report revenues for China and U.S. and international based on geographies of usage. For example, certain Chinese customers offer applications that primarily target end users outside China. Such revenues were previously included under U.S. and international, but we now include such revenues under Shengwang to reflect in terms of contractual relationships. For the same reason, we will report the number of active customers and the dollar-based net retention rate, or DBNRR, separately for Agora and Shengwang, although the definition of active customers remains unchanged. The calculation methodology of the retention rate is the same as the expansion rate, which is the term we previously used. As almost all revenues generated from Agora customers are denominated in U.S. dollars and almost all revenues generated from Shengwang customers are denominated in RMB, we calculate DBNRR in U.S. dollars for Agora and in Renminbi for Shengwang instead of converting everything into U.S. dollars. Revenues for Easemob's chat API business will also be included in calculating active customers and retention rates for the Shengwang business. A detailed explanatory note, including a recap of historical results reflecting these adjustments can be found on our Investor Relations website. Moving on to our financial results for Q1. Agora revenues were $15.1 million in the first quarter of 2023, an increase of 10.2% year-over-year and a decrease of 4.4% quarter-over-quarter. The year-over-year increase was primarily due to our business expansion and usage growth, while the quarter-over-quarter decrease was primarily due to challenging macroeconomic conditions. As we mentioned in previous earnings calls, interest rate hikes, worldwide inflationary pressures, and tightening of intercapital funding starting from the second half of last year had notably impacted some of our customers' business and financial conditions, as well as their ability to raise funding, which led to reduced usage of our products and increased pricing sensitivity. Shengwang revenues were $21.3 million in the first quarter of 2023, a decrease of 14.5% year-over-year and a decrease of 12.3% quarter-over-quarter. The year-over-year decrease was primarily due to the disposal of Easemob's customer engagement cloud business, a decrease in usage from the K12 academic tutoring sector following regulatory changes, and the depreciation of RMB against the U.S. dollar. If we exclude these factors, revenue denominated in RMB would have increased 2.7% year-over-year. The quarter-over-quarter decrease was primarily due to the disposal of the customer engagement cloud business, lower usage during the Chinese New Year holiday for Internet customers, and a longer-than-expected sales cycle for traditional enterprise customers. The dollar-based net retention rate for Agora is 130%. The dollar-based net retention rate for Shengwang is 92%, excluding revenues from the K12 academic tutoring sector. Moving on to costs and expenses. For my following comments, I will focus on non-GAAP results, 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, and impairment of goodwill. The non-GAAP gross margin for the first quarter was 63.3%, which was 0.3% higher than Q1 2022, mainly due to the disposal of the customer engagement cloud business, which had a lower gross margin. As we mentioned in our previous earnings calls, we restructured and reduced our global workforce in Q4 2022. As a result, non-GAAP R&D expenses were $17.4 million in Q1, a decrease of 31.2% year-over-year. Non-GAAP R&D expenses represented 47.8% of total revenues in the quarter compared to 65.6% in Q1 last year. Non-GAAP sales and marketing expenses were $8.5 million in Q1, a decrease of 26.3% year-over-year. Sales and marketing expenses represented 23.4% of total revenues in the quarter compared to 30% in Q1 last year. Non-GAAP G&A expenses were $6.9 million in Q1, a decrease of 7% year-over-year. G&A expenses represented 18.8% of total revenues in the quarter compared to 19.1% in Q1 last year. Non-GAAP operating loss was $9.2 million, translating to a 25.4% non-GAAP operating loss margin for the quarter compared to an operating loss margin of 49% in Q1 last year. Adjusted EBITDA was negative $6.4 million, translating to a 17.7% adjusted EBITDA loss margin for the first quarter, significantly lower than the gross margin of 42.6% in Q1 last year. Investment loss was $4.4 million in Q1, primarily due to the fair value change in equity investments of $2.9 million, credit loss in debt investments of $1.2 million, as well as disposal loss of $0.3 million. Now turning to cash flow: operating cash flow was negative $8.9 million in Q1 compared to negative $15.9 million last year. Free cash flow was negative $9.1 million compared to negative $17 million last year. Moving on to the balance sheet: we ended Q1 with $416.5 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 $9.1 million, share repurchase of $19.4 million, and cash paid in relation to the headquarters project of $5.1 million. During Q1, we repurchased approximately 21.6 million of our Class A ordinary shares, equivalent to 5.4 million ADSs, for $19.5 million, representing 10% of our $200 million share repurchase program. As of the end of Q1, we had, in aggregate, repurchased approximately 57.4 million of our Class A ordinary shares, equivalent to 14.4 million ADSs, for $61.3 million, representing 31% of our share repurchase program. Now turning to guidance: recently, we have seen increased uncertainties in macroeconomic conditions, such as foreign exchange rates, inflation, and interest rates, which may have a greater-than-expected impact on our customers' businesses and in turn, bring more uncertainty to our revenues. Therefore, starting this quarter, we will be providing quarterly revenue guidance instead of full-year guidance. For the second quarter of 2023, we currently expect total revenue to be in the range of $34 million and $37 million. This forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change. In closing, I want to express my deepest appreciation to both the Agora and Shengwang teams for their hard work during this challenging period and to our investors for their trust in our vision and our team. Thank you, everyone, for attending the call today. Let's open it up for questions.

Operator, Operator

Our first question comes from the line of Yang Liu from Morgan Stanley.

Yang Liu, Analyst

Two questions from my side. The first one is about the outlook. The number implies a largely flattish or slightly sequential decline in the second quarter. Could management share more about the outlook for Shengwang and Agora differently for the second quarter? Do you see further diverging of the growth trend or a similar trend in the next few quarters for the 2 entities? And my second question is regarding the AI impact to the company. Tony mentioned a lot in terms of the product and the customer demand or use case driven by the new AI technology. But I'm wondering if there is any potential cost savings room from the new technology.

Tony Zhao, CEO

All right. I'll discuss the demand from both markets. On the Shengwang side, we can broadly push our customers into 3 segments. One is domestic digital native, another is domestic digital transformation, and the last is overseas customers. On the digital native customers, recently, demand remained soft primarily due to macroeconomic challenges and regulation. However, in this segment, as I mentioned earlier, we also see large opportunities in generative AI-powered use cases, which will take some time. On the digital transformation side, recently, we saw longer sales cycles. But there is clearly a lot of unmet demand from traditional enterprises, which we expect to generate sustained growth for us. Ongoing overseas customers show strong overall growth momentum. On the Agora side, we see positive demand momentum in more developed markets, especially in the following verticals: live streaming e-commerce, Twitter economy, sports live streaming, and the future of work. For emerging markets, we see pressure on our customers due to macroeconomic challenges and market competition, such as in South Asia and Southeast Asia. That's from the outlook of the demand side. Regarding the generative AI side, we have invested in this area for quite some time to help improve audio/video quality. And as I mentioned, large language models can actually help create more use cases in many verticals. However, if your question is around cost reduction, I don't think it's going to hugely help us to reduce costs. But it may disrupt many business models, such as AI-powered tutors being much cheaper than real tutors or virtual celebrities and similar characters being cheaper, allowing platforms to maintain and pay for active AI personalities instead of real ones. I think that can disrupt those businesses significantly.

Operator, Operator

Our next question comes from the line of Daley Li from Bank of America Securities.

Daley Li, Analyst

I have one question regarding our international Agora business. For this quarter, it has delivered quite solid growth. What's the key drivers for our growth, for example, regarding the volume and ASP? And what's the outlook for the volume and ASP going forward?

Jingbo Wang, CFO

As we explained in previous earnings calls, the market in China and the market in the U.S. and international markets are at different stages of development in terms of adopting the RTE technology. The China market is comparatively more mature. In the past 18 to 24 months, we have seen the U.S. market catching up quite rapidly. For example, the live streaming e-commerce use case became popular in China 2 years ago, and probably even earlier. But that's really only taken off in the past 12 to 18 months in the U.S., creating a lot of new demand for technology. Also, we have been expanding into more geographic regions, including South Asia, the Middle East, and even South America. So that trend is stronger, causing momentum on the Agora side. Looking forward, as Tony just explained, in China, we do see more macro challenges and overall macroeconomic environment, coupled with regulation affecting more traditional enterprise customers in China. We also see more budget constraints. So looking at the next few quarters, we are also more optimistic about demand for the Agora side.

Operator, Operator

Our next question comes from the line of Ethan Zhang from Nomura.

Bing Duan, Analyst

This is Bing Duan from Nomura. I have one question regarding the China market. As we noted that there are a few changes in the competitive landscape, such as Ali Cloud's plan of spinoff and the recent price cuts from the large cloud companies like Alibaba and some Chinese telecom operators. So how do we see this impact our Shengwang business in China, such as the ASP and margins, and also about our future market share in China?

Tony Zhao, CEO

First of all, the public cloud price adjustment recently does not really relate to us and does not give pressure to us. However, in China, as I mentioned earlier, the overall competition has remained strong for a long time, and the demand is actually, especially for domestic native part, is soft. In this situation, we proactively enhance our competitive edge and occasionally reduce our pricing in certain areas to increase competitive pressure and try to gain more market share. Major public clouds have previously rolled out similar services in the RTE sector; honestly, there has been no one left. Everyone has released some similar products already. However, over the past 2 to 3 years, many of them have mostly exited the business. They either stopped really selling that product or some have started partnerships with us and added value to our products in their offerings. Thank you.

Operator, Operator

I am showing no further questions. I will now turn the conference back to Fionna for closing remarks.

Fionna Chen, IR Director

Thank you, operator. Thank you, everybody, for joining our call today. Again, if there are any further questions, feel free to contact us. The presentation and the remarks of this call will also be posted on our website. Thank you, everybody.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.

Jingbo Wang, CFO

Thank you. Bye-bye.

Tony Zhao, CEO

Bye.