Earnings Call Transcript - API Q2 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to Agora Inc. Second Quarter 2023 Financial Results Conference Call. Please be advised that today's conference is being recorded. The company's earnings results press release, earnings presentation, 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 what the company believes today and actual results may differ materially. These forward-looking statements are subject to risks and uncertainties and other factors that could affect the company's financial results and the performance of its business, which the company discussed in detail in its filings with the SEC, including today's earnings press release and the risk factors and 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 make on today's call. With that, let me turn it over to Tony. Hi, Tony.

Tony Zhao, CEO

Hi. Thanks, operator, and welcome everyone to our earnings call. Our revenue for the second quarter was $15.3 million for Agora, down 5.6% year-on-year, mainly due to a challenging global macro environment and tightening financial conditions of certain customers. Our revenue was RMB 131.5 million for Shengwang, down 11.7% year-on-year excluding revenue from the disposed customer engagement cloud business and K-12 academic tutoring sector, mainly due to a slowing economy and fast-evolving regulation in certain downstream verticals. As of the end of this quarter, we have 1,560 active customers for Agora and close to 4,000 for Shengwang, an increase of 24% and 5%, respectively, compared to one year ago. Now moving on to our business product and technology update for the quarter. First, starting with Agora. We recently announced our partnership with ActiveFence, a leading global provider of AI-driven content detection and moderation service. ActiveFence's solution keeps end users safe from the widest spectrum of online harms, unwanted content, and malicious behavior including adult content, bullying and harassment, child abuse, hate speech, illegal goods, violence, and more. We believe content moderation is particularly important for real-time engagement applications, given that content is generated and consumed in real time. Through our Extensions Marketplace, ActiveFence’s content moderation tools allow developers to easily add live audio and video content moderation functionalities to their applications without significant changes to their development processes. By detecting and removing all kinds of unwanted harms in real time, Agora and ActiveFence can help customers better handle emerging online safety and complex challenges while boosting end-user engagement in a safer and more trusted environment. On the use case side, over the past few quarters, we have seen an increase in real-time engagement adoption, and usage from vertical social networks or applications for interest-based communities. In typical use cases, creators, experts, or influencers in a specialized area such as meditation, yoga, astrology, religion, sports, or creative arts engage with their fan base through video calls or interactive live streaming sessions. A good example is Astrotalk, a prominent online astrology platform operating in over 60 countries with a network of over 5,000 astrologers. By leveraging Agora’s technology, Astrotalk introduced an innovative use case that enables video calls between clients and astrologers to be broadcasted simultaneously to multiple potential customers. The objective was to create a platform that would show astrologers providing live predictions to clients. When clients observe others talking with an astrologer, they are more inclined to engage with the same astrologer. As a result, Astrotalk has experienced remarkable threefold growth in active sessions following the launch of this feature. Moving on to Shengwang. In the past quarter, we upgraded our solution for high-definition video calling and live streaming. Previously, customers had to separately integrate our video-based product features and third-party extensions such as video enhancement for proprietary codecs, super resolution, beautification, and other video effects. It often took substantial time to find the most suitable architecture and specifications for the customer’s unique use case to deliver a balanced end-user experience considering video quality, latency, fluency, functionality, and device compatibility. With our new use case-oriented solutions, customers can now easily access best practices tailored to their specific use cases such as single-host live streaming, host PK, host-audience interaction, multiple hosts live streaming, and live shopping. Customers not only experience shorter development times but also benefit from an enhanced user experience. This ultimately leads to improved end-user retention and better monetization opportunities for our customers. For example, a dating platform recently adopted our comprehensive solution to upgrade their one-on-one and live streaming video from standard definition to high definition. In addition to the increase in video resolution, our solution also improved video quality in environments with poor or uneven lighting, provided video noise suppression, perceptual video coding, and beautification. As a result of the high-definition upgrade, the average user duration increased by more than 10%. Meanwhile, hosting matchmakers and the dating platform itself also generated higher tips and revenue. In early July, Shengwang was chosen as one of the 26 leading companies to showcase AI innovations at the 2023 World Artificial Intelligence Conference. Shengwang then demonstrated its AI-powered noise suppression capabilities based on deep learning algorithms, which can effectively remove more than 100 types of unwanted background noises and echoes, ensuring a disruption-free and more immersive experience for end users. Our AI noise suppression has been widely used by our customers across verticals such as telehealth, remote collaboration, social, and gaming. For example, our voice social platform realized a 5% increase in average session length after integrating our AI noise suppression into their application. Before concluding my prepared remarks, I would like to invite all of you to our upcoming RTE conferences. On Agora's side, the RTE program this year will consist of three events. We will launch with RTE Live Shopping, a month-long webinar series focused exclusively on this rapidly evolving space. Regional events for RTE India and RTE APAC will take place on October 5th. RTE India will be a fully virtual event highlighting how RTE technology is facilitating the evolution of new communities within Faith Tech, Astrology, Social, Media & Entertainment, Live Shopping, and Gaming. RTE APAC programs will be hosted in Korean and Indonesian languages, featuring key leaders and discussions around the Metaverse, education, and live shopping. We are excited to continue growing our global RTE community and foster the spirit of innovation through our conferences. On Shengwang's side, the conference will be held in Beijing from October 24th to 25th. This year’s conference will center around how the future of RTE will be shaped by generative artificial intelligence and high-definition immersive experiences. Together with industry-leading experts and practitioners, we will explore and envision the possibilities and advancements that this technology will bring to RTE. With that, let me turn things over to Jingbo, who will reveal our financial results.

Jingbo Wang, CFO

Thank you, Tony. Hello, everyone. Let me start by first reviewing financial results for the second quarter, and then I will discuss the outlook for the third quarter of 2023. Total revenues were $34 million in the second quarter of 2023, a decrease of 16.9% compared with the same quarter last year and a decrease of 6.6% quarter-over-quarter. Agora's revenues were $15.3 million in the second quarter of 2023, a decrease of 5.6% year-over-year and an increase of 1.3% quarter-over-quarter. The year-over-year decrease was primarily due to reduced usage of our products and customers' increased price sensitivity due to the challenging macroeconomic environment starting from the second half of last year. The quarter-over-quarter increase was primarily driven by usage growth and the emergence of use cases such as vertical social networks, as Tony just mentioned. Shengwang revenues were RMB 131.5 million during the second quarter of 2023, a decrease of 19.8% year-over-year and a decrease of 9.9% quarter-over-quarter. Excluding revenues from the disposed CEC business and K-12 academic tutoring sector, Shengwang revenue decreased 11.7% year-over-year and 8.8% quarter-over-quarter, which was primarily due to slowing general economic conditions and fast-evolving regulations in certain downstream markets. The dollar-based net retention rate for Agora is 108%. The dollar-based net retention rate for Shengwang is 91%, excluding revenues from the K-12 academic tutoring sector. Moving on to costs and expenses. For my following comments, I will discuss some non-GAAP adjusted financial measures, which exclude share-based compensation expenses, acquisition-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. The adjusted gross margin for the second quarter was 67.2%, which was 2.6% lower than Q2 2022, mainly due to a change in product mix and was flat compared to Q1 2023. As mentioned in previous earnings calls, we restructured and reduced our global workforce in Q4 2022, and we have continued to implement effective expense controls. As a result, adjusted R&D expenses were $16.6 million in Q2, decreased 37.4% year-over-year. Adjusted R&D expenses represented 48.8% of total revenues in the quarter compared to 64.8% in Q2 last year. Adjusted sales and marketing expenses were $7.1 million in Q2, decreased 34% year-over-year. Sales and marketing expenses represented 20.9% of total revenue in the quarter compared to 26.3% in Q2 last year. Adjusted G&A expenses were $6.2 million in Q2, decreased 9.5% year-over-year. G&A expenses represented 18.2% of total revenue in the quarter compared to 16.6% in Q2 last year. Adjusted EBITDA was negative $6.6 million, translating to a 19.5% adjusted EBITDA loss margin for the quarter, significantly lower than the adjusted EBITDA loss margin of 37.4% in Q2 last year. Investment loss was $1.9 million in Q2, primarily due to loss on investments in certain private companies of $4.9 million, which was offset in part by the fair value change in equity investments of $3 million. The non-GAAP net loss was $6.6 million in Q2, translating to a $19.4 million non-GAAP net loss margin for the quarter compared to a net loss margin of 50.8% in Q2 last year and 25.1% in Q1 this year. An extraordinary P&L item in this quarter was the impairment of goodwill. In Q2, we completed the integration of Easemob's operation, after which we only identified one reporting unit. Considering the natural impact on market demand as a result of the challenging global macroeconomic environment and regulatory changes in certain sectors, we performed quantitative impairment tests on goodwill and recognized the full impairment of goodwill in relation to the Easemob acquisition, which is $31.9 million. As of the end of Q2, there was no goodwill outstanding on our balance sheet. Now turning to cash flow. Operating cash flow was negative $5.3 million in Q2 compared to a negative $23.8 million last year. Free cash flow was net $5.6 million compared to negative $24.2 million last year. Moving on to the balance sheet. We ended Q2 with $391.6 million in cash, cash equivalents, bank deposits, and financial products issued by banks. Net cash outflow in the quarter was mainly due to free cash flow of negative $5.3 million and share repurchase of $21 million. Since the Board approved our share repurchase program in February 2022, as of June 30, 2023, we have returned approximately $82 million to shareholders through share repurchases, demonstrating the Board's commitment to safeguarding shareholder value and its confidence in the long-term prospect of the company. As of June 30, 2023, the company had approximately 97.5 million ADS outstanding, reflecting a reduction of approximately 14.9 million ADS or 13% reduction of total shares outstanding from January 31, 2022, before the share repurchase program started. So far, we have completed 41% of the $200 million share repurchase program, which will expire at the end of February 2024, and we intend to continue to undertake meaningful capital return to our shareholders. Now turning to guidance. For the third quarter of 2023, we currently expect total revenues to be between $34.5 million to $36.5 million. This forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change. In closing, we are confident about the long-term prospects of the global market for real-time engagement technology, and we are well-prepared for near-term uncertainties and challenges. Thank you to both Agora and Shengwang teams for their hard work and our investors for their trust. Thank you, everyone, for attending the call today. Operator, let's open it up for questions.

Operator, Operator

Our first question comes from Yang Liu at Morgan Stanley.

Unidentified Analyst, Analyst

This is Lydia representing Yang Liu from Morgan Stanley. So our question is for management, can you review your observation of the demand recovery situation, both in the domestic and overseas market and as well as your outlook for the second half of this year?

Tony Zhao, CEO

Sure. In terms of the market – I would divide this into the U.S. international market and China market. So for the U.S. and international market, we do see pretty healthy demand from verticals such as e-commerce, vertical social networks focused on certain interest groups, like just mentioned, education, and IoT are sectors that are doing pretty well at the moment. On the other hand, emerging markets and certain use cases that were popular given the pandemic, such as online events are relatively weaker. On the China side, demand from the digital transformation sector is more resilient, such as financial institutions and large enterprises, and we also see healthy demand from professional training and academic education. Within the social entertainment sectors, despite the pretty challenging regulatory environment in China, we see promising growth from customers operating apps in China, and we see pretty healthy demand growth there. On top of the regional situation, I’d also like to comment on the product side. We see a lot of customer demand for AI-based features such as content moderation, real-time transcription, and also pretty healthy demand for products based on high-definition video. So in terms of full year outlook, we are cautiously optimistic that demand will gradually improve overall during the remainder of the year, driven by these new products I just mentioned, and at the same time, offset by ongoing macro challenges, both in China and also in other emerging markets.

Operator, Operator

Our next question comes from the line of Harry Zhuang from Bank of America Securities.

Harry Zhuang, Analyst

I have two questions. First one is regarding the margin trend. Can you give us some outlook of the gross margins in the next two quarters and also about next year? And the second question is what is the plan for the AI products and the future revenue contribution for the company?

Jingbo Wang, CFO

On the gross margin, as you can see, sequentially, is basically flat, and it's currently at a pretty healthy level. So we do expect gross margin to remain relatively stable for the remainder of the year as we continue to optimize our cost structure. As for next year, it's probably still early to say, but our plans certainly to try to maintain stable and healthy gross margin levels.

Tony Zhao, CEO

As to the AI-related document and product, actually, our high-definition video initiative is a product that leverages AI capabilities to greatly improve video performance. We believe we are the first ones that are able to provide mobile real-time video to the level of true HD state; the first mature mobile 1080P real-time video solution is based on this HD initiative. Also, our third-party expansions, like what I mentioned in opening remarks, ActiveFence, are also leveraging AI technology to moderate real-time content and activities. Our other products, such as real-time transcription, also leverage AI. As a much bigger trend, the AIGC development is very encouraging. We firmly believe generative AI will expand the boundaries of RTE and significantly enhance end-user experience, but it won’t be a short-term revenue contributor as voice and video multimodal capabilities are still at their early stage for all major large models. We have been working closely with customers on certain vertical use cases leveraging AIGC, such as AI-powered game players and real-time voice-based AI companies. We expect to make product launch announcements in the coming months. In addition, AIGC will also be one of the main topics of our upcoming RTE conference in October. We will also have the latest demo showcase during this conference on AIGC. Please join us for a deeper and more detailed discussion.

Operator, Operator

Our next question comes from the line of Wong from Citic.

Unidentified Analyst, Analyst

Actually, two questions from my side. And the first one is that, has there been any change in the company's guidance on the profit? And will there be any more related optimization within the year?

Tony Zhao, CEO

Can you repeat your second question?

Unidentified Analyst, Analyst

And will there be any more related optimizations about the resource within the year?

Tony Zhao, CEO

I'll take those questions. So despite the recent macroeconomic challenges and regulatory challenges, we remain committed to our goal of achieving non-GAAP net income breakeven in Q4 this year. We believe we are now operating at a quite efficient level with the right team size. So our focus in Q3 is really to drive revenue growth rather than further cutting headcount costs; but as we see revenue recover, we will make incremental savings. We think we still have a good chance of achieving our non-GAAP net income breakeven towards the end of the year.

Unidentified Analyst, Analyst

And my second question is that has there been a noticeable change in the domestic and international competitive environment? That's my last one.

Tony Zhao, CEO

Sure. There hasn’t been much change in the overall competitive landscape. In China, the competitive landscape remains the same as the previous quarter. But in the U.S. and international markets, we see slightly increasing competition from regional start-ups. I think this is a good thing overall for the industry, with more choices for customers and more ideas to drive the industry forward. Together, we will create a more vibrant market and accelerate the adoption of RTE technology in general. The recent macroenvironment challenges will also impact those competitors, especially for smaller players in the market. We have also seen some companies go out of business. Overall, the competitive landscape remains largely the same. We’re still the clear leader in this space in terms of technological performance and completeness of features. With the right focus and execution, I think we are well positioned to gain market share during this challenging period.

Operator, Operator

I'm showing no further questions in the queue. This concludes our Q&A. Thank you, everybody, for attending the company's call today. As a reminder, the recorded earnings release will be available on the company's website at investor.agora.io. And if there are any questions, please feel free to e-mail the company. Thank you.