AppLovin Corporation (NASDAQ:APP) Q3 2023 Earnings Call Transcript

AppLovin Corporation (NASDAQ:APP) Q3 2023 Earnings Call Transcript November 8, 2023

AppLovin Corporation beats earnings expectations. Reported EPS is $0.3044, expectations were $0.27.

David Hsiao: Welcome, everyone, to the AppLovin Earnings Call for the Third Quarter ended September 30, 2023. I’m David Hsiao, Head of Investor Relations. Joining me today to discuss our results are Adam Foroughi, our Co-Founder, CEO and Chairperson; and Herald Chen, our President and CFO. Please note, our SEC filings to date as well as our shareholder letter and press release discussing our third quarter performance are available at investors.applovin.com. During today’s call, we will be making forward-looking statements regarding our products and services, market expectations, our CFO transition, 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.

Our 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 June 30, 2023, and our Form 10-Q for the third 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 and 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. Now I’ll turn it over to Adam and Herald for some opening remarks, then we’ll have the moderator take us through Q&A.

Adam Foroughi: Good afternoon. Thank you for joining us today. Our team has executed exceptionally well. This quarter’s record-breaking performance is a testament to the success of our new AI-based advertising technology, AXON 2, which has once again driven revenue and adjusted EBITDA above our expectations. I would like to take a moment to commend our outstanding team for their dedication and hard work. A year ago, we faced significant challenges, yet our teams resolve and enthusiasm never faltered. Our efforts this year have not only solidified our short-term growth trajectory but have also set the stage for sustained long-term expansion. The journey with AXON 2 is just beginning with numerous enhancements on the horizon.

This quarter, we made strides by integrating AXON 2 into our CTV initiative during its testing phase, and we are planning to scale up these efforts in the subsequent quarters. We are excited about introducing our leading performance marketing technologies to television, where we see a substantial opportunity to fill a gap with the superior performance solution. Additionally, this quarter, we’ll be extending AXON 2 to Array and expect it will materially accelerate the potential to scale that business. Considering the magnitude of our software platform business, we’re investing in our CTV and Array businesses because we believe they have the potential to become meaningful contributors to our annual revenue. Our dedication to creating long-term value for our shareholders is steadfast.

We are confident in the capabilities of our team, the potential for the innovation of our technology, the quality of our products and the strength of our financial position. We are grateful for your trust and support as we embark on the next chapter of our journey, which promises growth and relentless innovation. Before concluding, I would like to express my gratitude to Herald for his many contributions during his tenure as CFO over the past 4 years. Herald’s ambition to build a strong foundation in our support and operational functions has been realized, setting us on a course for operational excellence. As we transition to provide more opportunities for his team, Herald will continue to offer invaluable strategic guidance in his new advisory role to me.

I will now turn it to Herald who will share the financial highlights of the quarter. Thank you again for your continued support.

Herald Chen: Thanks, Adam, and thanks for the kind words. As Adam discussed, strong execution across the board led to fantastic financial performance this past quarter. In Q3, we achieved incredible year-over-year and quarter-over-quarter revenue growth, with software platform up 65% year-over-year reaching a $2 billion run rate. Apps posted the first quarter of quarter-over-quarter revenue growth since we started our portfolio optimization program. In total, generated revenue of $864 million, up 21% year-over-year with adjusted EBITDA of $490 million, up 63% year-over-year, both exceeding the high end of our guidance. Given higher margins and higher contribution from our software platform business, total adjusted EBITDA reached the highest EBITDA margin in 5 years at 48.5% margin, an improvement quarter-over-quarter of over 400 basis points on top of a 600 basis points improvement from Q2 over Q1 2023.

Of note, this past quarter did benefit from approximately 100 basis points of improvement coming from onetime nonrecurring cost benefits. Turning to our segment reporting. We are excited to see our software platform and AI-driven technologies to help our advertising partners expand the reach, achieve better returns on their investments and increase their spending with us. The software platform reached record revenue of $504 million, a 65% increase over the prior year and a 24% increase quarter-over-quarter, which is the third consecutive quarter with double-digit quarter-over-quarter revenue growth. Software Platform adjusted EBITDA grew 91% year-over-year and 33% quarter-over-quarter to $364 million, with a record 72% adjusted EBITDA margin.

Our software platform continues to demonstrate high flow-through from revenue to adjusted EBITDA as we scale. Given its extraordinary growth in cash flow generation, software platform adjusted EBITDA now represents nearly 90% of our company’s total adjusted EBITDA. As Adam mentioned, we’re very proud of our software platform team’s hard work and accomplishments to date but we’re even more excited about where this business can go in the future, both within our core markets and within the new initiatives we have been pursuing with Wurl and Array. Moving on to the App segment, apps revenue grew 5% sequentially to $360 million, the first quarter of growth since we started our portfolio optimization project. Apps adjusted EBITDA was $55 million, a margin of 15%.

With the major parts of our portfolio review complete, we are continuing to focus on balancing growth and cash flow to optimize the financial performance and enterprise value of our apps portfolio. With regard to free cash flow, we generated $194 million in Q3. The flow-through from adjusted EBITDA to free cash flow in Q3 is slightly lower than normal, primarily due to a temporary delay in certain cash collections which we expect will reverse itself in Q4. As previously mentioned in our calls, adjusted EBITDA to free cash flow flow-through is typically 50% to 60% on a normalized run rate basis, noting that we typically have some deviations in any particular quarter driven by the timing of tax payments and working capital movements. This flow-through percentage should increase over time as our high cash flow converting software platform business continues to grow faster than the apps.

With regard to guidance for Q4 2023, we are targeting another quarter of growth with revenue between $910 million and $930 million, adjusted EBITDA between $420 million and $440 million and margin between 46% and 47%. Margin outlook is slightly down from Q3’s 48.5% given an approximately 100 basis point benefit from onetime items in Q3 and the potential for further investments in the business in Q4. From a cash perspective, we ended Q3 with $332 million of cash in the balance sheet. In the quarter, we used $582 million of cash to buy back stock and $249 million to pay down our term loan. This was offset by $185 million drawn on the revolver. Regarding stock buybacks. Year-to-date, through the end of the third quarter, we have repurchased $1.2 billion of our Class A common stock at a weighted average price of under $25 per share.

This is consistent with our asset allocation plan and focus on driving long-term shareholder value. On the debt side, in Q3, we amended a portion of our term loans, extending the maturity to 2030, reducing principal amount by $250 million — $249 million and improving our credit spread. With regard to our Board, we’re pleased to add Todd Morgenfeld in the quarter, a seasoned executive who most recently was a CFO at Pinterest and prior to that, was VP Finance at Twitter. Concurrently, Asha Sharma, COO of Instacart, stepped down from the Board. Overall, our strong Q3 performance showcases the strength and powerful business model underlying our software platform business. Lastly, on a personal note, as Adam mentioned earlier, I’ve decided to transition from a full-time role to an advisory one at the end of this year so I can take some time off and investigate new opportunities.

In my new role as adviser to the CEO, I very much look forward to working with Adam and the team on key strategic and financial matters. Further, I will be continuing my service on the AppLovin Board. It has been my privilege to serve as AppLovin President and CFO for the past 4 years, in particular, getting to help build and work with this truly extraordinary management team. Come January, I’m excited to have Matt and Dimitri step into their new and well-deserved leadership roles. Based on their track record and past contributions, I am confident in their success. Since joining the Board in 2018, under Adam’s leadership, the company has achieved tremendous growth, increasing revenues by over 6x and adjusted EBITDA as multiplied from a couple of hundred million dollars of run rate to over $1.6 billion run rate today.

While the path has not always been linear, nor easy, the team has remained steadfast and executed with expertise to drive this outstanding performance. Thank you to all the AppLovin stakeholders, including our team, customers, partners, shareholders, lenders and Board who have supported us along our journey thus far. I do say thus far because the opportunity ahead of AppLovin is awesome and I very much look forward to being a part of it in my new role. Now the moderator will take us through Q&A.

Operator: [Operator Instructions] And our first question is going to come from Ralph Schackart with William Blair.

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Q&A Session

Ralph Schackart: First question, just on the overperformance in the quarter. Maybe you could kind of speak to maybe what’s going better with the sort of ramp of EXON 2 than you originally anticipated. And perhaps maybe you could kind of touch on, I think, historically, you talked about it extended beyond gaming, maybe some perspective on how it’s doing in some of the other verticals? And then I have a follow-up, please.

Adam Foroughi: So we talked about last quarter, AXON 2 was rolled out partial way in the prior quarter. This is a brand-new technology, and it’s a self-learning type of technology. These AI models as they get scaled, continuously improve themselves. And then our team also is able to continuously improve them. So we’re talking about a new technology that we’ve seen is one, been game changing for our business and is too in the first inning. And that’s what gets us really excited. The output of the technology delivers better results for advertisers. And we’ve seen it to your question on gaming or non-gaming, we’ve seen it agnostic of the category. Advertisers on our platform are spending more dollars in a material way at better returns. And that is a model that just compounds on itself. And so that’s what led to the vast majority of the over performance this past quarter. It works much better for both non-gaming and gaming.

Ralph Schackart: And then during the prepared remarks, Adam, you talked about extending EXON 2 to the Connected-TV business and Array and then, will at some point, contribute to results. Just kind of carry some perspective in your opinion, when it can start adding to the overall, sort of, enterprise results?

Adam Foroughi: Yes. I mean we did the World deal, I think it was last April, right? So it’s been about 1.5 years. World teams integrated, they’ve built out really good product offerings on Connected-TV, part of that is an SSP. So there’s a lot of inventory available on World’s platform now for us to step into it and buy it with our performance marketing model. And in the last earnings call, we talked about we’re just going to start migrating AXON 2 over to the Connected-TV offering. We’ve gotten the testing phase on that. As we start scaling that, we’re very excited about the potential of that platform. Obviously, it’s television, and we all also know that performance marketing on TV hasn’t really been thing anywhere near as much as it has been on desktop or on mobile devices.

And so our technology is truly cutting-edge and being able to extend into that platform presents a very big opportunity. And then Array is the same deal, Array, gets us on Android devices today in a much more intimate way. It presents multiple new ad offerings to the consumer and being able to use the AXON 2 solution there. We think is also going to be game changing for that business and the prospects of both.

Operator: Our next question will come from Clark Lampen with BTIG.

Clark Lampen: Adam, I was hoping maybe we could unpack a little bit of the sort of sequential uplift that we saw in software revenue. You talked about it being a testament to AXON 2 at the top of your prepared remarks. Was that the key driver in the sort of lift we saw up to $500 million? Or were there other businesses like World or maybe MAX also contributing?

Adam Foroughi: Yes, that’s vast majority of AXON 2. That powers the App Discovery platform or advertising business, and that’s already the vast majority of the software platform, but AXON 2 is the key catalyst.

Clark Lampen: Got it. And as we look at, I guess, sort of the forward guidance, if you were to assume I guess just for discussions sake that the apps business is running flat. We’re sort of seeing like a 9% to 13% uptick in software revenue into the fourth quarter. Is that still expected to be mostly driven by app discovery, AXON, sort of the compounding effect of the improvements that you’ve talked about historically?