AppLovin Corporation (NASDAQ:APP) Q2 2023 Earnings Call Transcript

AppLovin Corporation (NASDAQ:APP) Q2 2023 Earnings Call Transcript August 9, 2023

AppLovin Corporation beats earnings expectations. Reported EPS is $0.22, expectations were $0.08.

Operator: Please standby, we are about to begin.

David Hsiao: Welcome everyone to the AppLovin Earnings Call for the Second Quarter Ended June 30, 2023. I am David Hsiao, Head of Investor Relations. Joining me today to discuss our results are Adam Foroughi, our Founder, CEO and Chairperson; and Herald Chen, our President and CFO. Please note our SEC filings to-date, as well as our shareholder letter discussing our second quarter performance are available at investors.applovin.com. During today’s call, we may be making forward-looking statements regarding our product and services, market expectations, the future financial performance of the company and other future events. These statements are based on our current assumptions and beliefs, and we assume no obligation to update them except as required by law.

Actual results may differ materially from the results predicted. We encourage you to review the risk factors in our most recently filed Form 10-Q for the fiscal quarter ended March 31, 2023 and in our Form 10-Q for the second quarter, which we expect to file later today. We will also be discussing non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for or superior to our GAAP results. Please be sure to review the reconciliations of our GAAP to non-GAAP financial measures in our shareholder letter available on our Investor Relations site. This conference call is being recorded and a replay will be available on our IR website. I will turn it over to Adam and Herald for some opening remarks. Then we will open up for Q&A.

Adam Foroughi: Good afternoon, everyone, and thank you for joining us today. We had a stellar second quarter, surpassing our revenue and adjusted EBITDA guidance, largely due to the expansion of our Software Platform business. I am incredibly proud of our dedicated teams who have worked tirelessly to upgrade our advertising algorithms from AXON 1 to AXON 2. We started talking to you a year ago about the benefits we achieve both short- and long-term by upgrading our technology and now we have executed on it. The launch has not only paved the way for a strong quarter, but also provides us with additional opportunities for future growth. The introduction of such a significant change in our technology required many hours of hard work, innovation and risks taken.

The result is a true testament to our spirit and commitment and demonstrates that we operate with the same speed and efficiency as we did in our time as a private company. This is what makes me particularly proud of what we have achieved. with cutting edge AI technologies at the heart of our core offering. Our focus will now shift towards continuous enhancement of our technology, expanding our advertiser base and extending AXON 2 to our Wurl and Array businesses. We are optimistic that these measures will fuel growth for years to come. In conclusion, we remain committed to providing long-term shareholder value. We are confident in the potential of our team, our technology and our products, and our financial strength. We appreciate your trust and support and we look forward to our journey of growth and innovation with you.

Thank you. On to Herald to provide you with our financial highlights.

Herald Chen: Thanks, Adam, and good afternoon. Based on the incredible efforts from our team this year, in particular, leading the launch of our AXON 2.0 engine, we had a strong quarter financially across the Board, with record Software Platform revenue, high margins, impressive operating leverage, and ultimately, robust free cash flow. Our strong performance in the quarter illustrates that the highly focused plan we articulated about a year ago is working. As a reminder, we said we invested in our core team, improve our AI-based platforms and technology, optimize our apps business, drive free cash flow and simplify. Simplify, focus and execute against what we do best. That strategy and plan, which is very similar to the fundamentals on which this company was founded are working and we are excited about where that can take us.

Touching on our financial highlights for the quarter. Our total revenue reached $750 million, with adjusted EBITDA of $334 million, both exceeding the high end of our guidance. Our adjusted EBIT margin — EBITDA margin was 44% and was the highest EBITDA margin we have had in five years. Further, for the quarter, we are pleased to have generated $80 million of positive net income. Our Software Platform segment reached a record revenue of $406 million, which represents two quarters with consecutive mid-teens growth and an increase of 28% over the prior year. Software Platform adjusted EBITDA grew 39% year-over-year and 25% quarter-over-quarter to $273 million, translating to a 67% adjusted EBITDA margin. Software Platform adjusted EBITDA now represents more than 80% of our company’s total adjusted EBITDA.

Of note, during the quarter, we were able to increase adjusted EBITDA by an amount slightly higher than the increase in revenue, equating to over 100% flow-through. While our flow-through will fluctuate in the future, it does highlight the impressive operating leverage from our Software Platform segment. As our Software Platform revenue continues to grow, we expect high flow-through and further margin improvements for this segment. Looking at this segment over the past two years, revenue increased by 2.8 times, representing a 67% compounded annual growth rate. Over that same period, our Software Platform adjusted EBITDA grew 3 times, a 70% CAGR. We continue to remain optimistic about our opportunities within the Software Platform segment as we continue to improve our AI-based technologies, as well as invest in our growth initiatives, including Connected TV and carrying OEM.

Turning to the App segment. During the quarter, we continued to focus on balancing profitability with revenue. For Q2, we had $334 million of Apps revenue and $61 million of adjusted EBITDA, a margin of 18%. We continue to invest carefully to drive topline growth, both through new game development and user acquisition marketing, while also managing for overall margin, target a mid-teens adjusted EBITDA margin range over the medium-term. At the consolidated level, we are pleased to report we had free cash flow of $221 million in Q2, a 66% flow-through of adjusted EBITDA to free cash flow. For the first half of 2023, we generated over $0.5 billion in free cash flow. With regard to guidance for Q3 2023, we are targeting another quarter of growth, with revenue between $780 million and $800 million, adjusted EBITDA between $340 million and $360 million and adjusted EBITDA margin between 44% and 45%.

We anticipate the first full quarter of revenue contribution from AXON 2.0 to continue driving our growth, as well as see steadier Apps performance. As previously mentioned on our calls, we continue to target free cash flow of approximately 50% to 60% of adjusted EBITDA on a normalized run rate basis, noting that we may have deviations from that in a particular quarter. From a cash perspective, we ended Q2 with $876 million of cash on the balance sheet. In terms of stock buybacks, we repurchased $507 million of our Class A common stock during the quarter and year-to-date through August 8, we have repurchased $601 million. We have $107 million of authorization remaining under our repurchase program and we will be carefully watching the markets.

We are also watching the leveraged loan markets in real-time to see if we can extend, reduce and/or lower the cost of our term loans. If we see an attractive window, we will move quickly to optimize our capital structure. In conclusion, Q2 was an incredibly strong financially and exemplifies the strength of our business model. Looking forward, our teams continue to be focused on execution and improving our core solutions and technologies. As Adam said, we are very excited about the opportunities in front of us. And now the moderator will take us through Q&A.

Operator: Great. Thank you so much, Herald. [Operator Instructions] And we will go first to Morgan Stanley’s Matthew Cost. Matthew, looks like Matthew is on audio-only everyone. Just second. Matthew, go ahead. Okay, Matthew, I see you unmuted.

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Q&A Session

Unidentified Analyst: All right. sorry. Can you hear me?

Operator: Go ahead. Yeah. Yeah. We should and please go ahead.

Unidentified Analyst: Great. Thanks. Hi. It’s Dave [ph] on for Matt Cost. And so, sorry if I missed this earlier, there were a few technical difficulties with the audio here for those of us dialing in. But with the strength of the ad network results, I think, that speaks pretty positively to the company’s execution in the quarter. Are you able to give some color on perhaps what portion of the quarter’s performance you would find attributable to your own execution versus an overall recovery in the market? Thanks.

Adam Foroughi: Thanks, Dave, for the question. Market has been steady as we have been talking about for a couple of quarters now. So we attribute the growth in our platform really 100% from the advancements in our core technology. The upgrade made our platform a lot more accurate for advertisers and allows us to really monetize more of a breadth of advertisers. So being able to do both things enabled us to really grow our business on the back half of the quarter as we rolled out this technology. And more importantly, we are driving better value to the advertisers. So we expect this not only to contribute to the growth that we have in the short-term but also the long-term and that’s what gets us really excited.

Unidentified Analyst: Great. Thanks. And maybe just one follow-up, if I could. If we assume that the gaming continues along the trajectory, the guide implies 45% to 50% Software revenue growth year-over-year. How do you view the sustainability of the gains and should we anticipate a similar step function that we saw in AXON 1.0?

Herald Chen: Yeah. We do view the App side of the business reaching some stability as we have discussed over the past few quarters that the second half of this year. We do see that and we are investing in some new games. We are investing more on user acquisition. In particular, given the fact that we are using a lot of our own solutions there, which has become more efficacious. So we do see our ability to drive some growth over the second half of the year. In terms of the Software side, AXON 2.0 is relatively new. It was launched this last quarter, a full run rate this quarter and we do see an improvement in growth and that is built into our guide for the third quarter.

Unidentified Analyst: Perfect. Thanks.

Operator: Great. And we will now hear from Ralph Schackart with William Blair.

Ralph Schackart: Great. Hey, Adam. Hey, Herald. Just looking at the really strong margins that you delivered this quarter, I think, around 44% and guiding for 44% to 45%, I think, next quarter. Historically, the model has contemplated sort of mid-30%s, maybe low 40% or 40% model. Is this a new baseline for margins that we should think about, especially given expectation for further Software margin improvement and growth going forward? And then I have a follow-up.

Herald Chen: Yeah. Thanks, Ralph, for the question. On the Software side, a 67% margin was a great quarter. As we mentioned in the introduction, we also had very high flow-through. We actually generated more EBITDA than we did relative to the incremental revenue. That doesn’t necessarily continue going forward, but it’s a very high flow-through model there. So we do believe that the margin will continue to expand on Software as we are able to grow the topline over the medium- and long-term, maybe not quarter-to-quarter, given vagaries due to timing. And on the App side, we have always said that we target more in the mid-teens range for EBITDA margin, whereas this past quarter, we are in the high-teens at 18%. As we invest a bit more on the UA side to grow the games that will probably bring down that margin down into the mid-teens.