Earnings Call Transcript - APP Q1 2025

David Hsiao, Head of Investor Relations

Welcome to AppLovin's Earnings Call for the First Quarter ended March 31, 2025. 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 Matt Stumpf, our CFO. Please note our SEC filings to date as well as our financial update and press release discussing our first quarter performance are available at investors.applovin.com. During today's call, we will be making forward-looking statements including, but not limited to, the future development and reach of our platform, our expected growth opportunities, the result and timing of our proposed sale of our games business, the efficiency of our operations, the expected 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-K for the year ended December 31, 2024. Additional information may also be found in our quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2025, which will be filed today. We will also be discussing non-GAAP financial measures. These non-GAAP measures are not intended to be superior to or substitute for our GAAP results. Please be sure to review the GAAP results and the reconciliations of our GAAP and non-GAAP financial measures in our earnings release and financial update available on our Investor Relations site. This conference call is being recorded and a replay will be available for a period of time on our IR website. Now, I'll turn it over to Adam and Matt for some opening remarks, then we'll have the moderator take us through Q&A.

Adam Foroughi, CEO and Co-Founder

Thank you all for joining us today. Q1 2025 was another fantastic quarter, marked by resilience and robust growth. After seeing the stock price rise roughly 50 times in two years, we faced short seller scrutiny, which we've addressed comprehensively and won't revisit here. Our mission remains clear, helping advertisers reach new customers profitably. It's important to remember, in our business, our only financial incentive is to drive measurable revenue and profitability to our advertisers. Without that, we could not scale our business nor would we get paid. As a leading performance marketing platform, our technological innovations have catalyzed the return to growth in the gaming ecosystem, reviving an industry that would otherwise be struggling without our advancements over the past two years. We've empowered sophisticated media buyers investing over $10 billion annually with us driving strong returns and generating significant impact for their businesses. We're now expanding into broader categories, confident in our ability to fuel their growth as we did for gaming. Few platforms operate at our scale, and we're proud of our role in driving economic growth. Our partners' vocal support this quarter was inspiring, and we're doing more business than ever. Let's dive into our outstanding Q1 performance. The first quarter is typically challenging for advertising due to seasonality and fewer days compared to Q4, yet we achieved remarkable growth. How? We further refined our machine learning models enabling mobile gaming companies to scale their campaigns on our platform. Less significant, but impactful was a full quarter contribution from web advertisers. This diversification is transformative and fuels our excitement for what's ahead. Today, we're thrilled to announce the signing of the definitive agreement to sell our games business in its entirety. This strategic move sharpens our focus on advertising. To our studio teams, you've been instrumental in building the technology that powers our Axon platform. As you transition to a company dedicated to game development, we're grateful for your contributions and excited for your future. Now, looking ahead, we're focusing all resources on three key priorities for 2025. First, we're relentlessly improving our machine learning models. Our research science team is leveraging rapid AI advancements to deliver even greater value to our partners, ensuring our platform remains a performance leader. Second, we're advancing our e-commerce and web advertising solutions with three areas of focus. We're continuously refining our models. While our product already works well for many advertisers, it's still early days, and we believe it can be significantly better. Each iteration brings us closer to that goal. We're enhancing integrations with third-party platforms and attribution vendors to provide advertisers with a seamless measurement experience. The web advertising space is more fragmented than apps, so this will take time, but it's a straightforward task. We're also developing a self-service dashboard, and we'll be launching it this quarter for select customers. Once fully rolled out, this tool will enable seamless automation, allowing new advertisers to set objectives, budgets, upload ads, and let our system deliver results. While we've seen great performance so far in our web advertising pilot, we're currently less than 0.1% of the potential market of total advertisers. Each new partner adds to our growth. It will take a few quarters to refine these tools for a broader release, but when we launch self-service globally, we expect it to unlock a massive opportunity. Third, we're enhancing ad testing and automated ad creation. Improving the creative experience is a priority this year, enabling advertisers to better optimize campaigns effortlessly. These initiatives are both immediate and long-term, positioning us for sustained success. Now, let me address the potential impact of tariffs. 90%-plus of our revenue in advertising comes from mobile games, which aren't directly impacted by tariffs. In web-based advertising, some assume we rely heavily on large Chinese e-commerce businesses, which are impacted by the de minimis tariff exemption changes. In reality, we focus on mid-market web advertisers and aren't yet working with the largest players, as we're refining our tools first. It is absolutely possible some of the merchants we do work with will have their businesses impacted by tariffs. However, with such low market penetration, we're well-positioned to grow through macroeconomic changes like tariffs without any visible impact on our business trajectory. I also want to address a few topics in the news. On competition, we embrace it. It drives innovation and pushes us all to improve. With our growing data moat and AI expertise, we're confident in our leadership and ability to grow rapidly regardless of others' advancements. Regarding potential alternative payment systems in the App Store, we see this as a positive. Lower fees for content developers, our customers, means they can invest more in user acquisition, which benefits our platform. For context on our TikTok bid, please see my blog post we published a few minutes ago. Our lean team continues to impress, showcasing a model for how AI-based businesses can operate efficiently. Our run rate adjusted EBITDA per employee in our Advertising business has risen to approximately $4 million annually, reflecting our commitment to operational excellence and robust economics. Thank you for your continued support as we execute our vision to build one of the world's most influential marketing platforms. With each quarter, I grow more confident in our ability to deliver incremental value to our partners. With that, I'll turn it over to Matt for a deeper dive on our financials.

Matt Stumpf, CFO

Thanks, Adam. And thanks to everyone for joining us today. We're thrilled to share that Q1 was another outstanding quarter for us, showcasing the strength and efficiency of our business model. Total revenue soared 40% from the same period last year to $1.5 billion, and adjusted EBITDA increased a remarkable 83% to an impressive $1 billion, achieving a fantastic 68% adjusted EBITDA margin. We've driven a 600-basis-point increase in our EBITDA margin over the previous quarter, a testament to our ability to leverage our primarily fixed cost base while fueling revenue growth through cutting-edge technology. In the first quarter, we generated $826 million in free cash flow, up a staggering 113% year-over-year. Quarter-over-quarter, our free cash flow grew 19%, representing an impressive 82% flow-through from adjusted EBITDA to free cash flow. At the end of the first quarter, we had $551 million in cash and cash equivalents. This quarter, we repurchased and withheld a total of 3.4 million shares for a total cost of $1.2 billion, primarily funded through our free cash flow as well as a temporary draw on our revolving credit facility, which we've now repaid. As a result of our strategic share management activities, we were able to reduce the total outstanding shares, net of share issuances to employees, demonstrating our commitment to delivering value to shareholders, and ended the quarter with 338 million shares outstanding. Shifting to the Advertising business, we generated $1.16 billion in revenue and $943 million in adjusted EBITDA, achieving an incredible 81% margin. Our revenue growth in the quarter was driven by a combination of factors, including continued enhancements in our AI-driven technology, which has delivered even better performance for the advertisers using app discovery and the full quarter impact of our web-based advertising solution, which continues to perform strongly while coming off a seasonally high spend period for e-commerce. Quarter-over-quarter flow-through from revenue to adjusted EBITDA was an exceptional 104%, which is slightly higher than our normal levels due to certain non-recurring costs last quarter. However, after adjusting for these costs, our flow-through was still a robust 100% despite the step-up in data center costs I mentioned last quarter, highlighting our dedication to operating lean while scaling smartly. As Adam mentioned, we're excited to share that we've signed a definitive agreement with Tripledot Studios to divest our Apps business. Consideration includes $400 million in cash and a 20% ownership stake in the combined business. Subject to regulatory clearance, we anticipate closing this transaction in the second quarter, and we're confident in the success this business will achieve under new leadership while we sharpen our focus on advertising. Finally, turning to our financial guidance for next quarter. In light of the Apps sale and our strategic focus on the Advertising business, we will only provide guidance for our Advertising segment. In the second quarter of 2025, for the Advertising business, we anticipate delivering between $1.195 billion and $1.215 billion in revenue, with adjusted EBITDA between $970 million and $990 million, targeting an adjusted EBITDA margin of 81%. We're confident these targets position us to continue driving strong growth and value for our partners and shareholders. Now, with that, let's move to Q&A.

Operator, Operator

We will now begin the question-and-answer session. First up is Jason Bazinet at Citi.

Jason Bazinet, Analyst

Good afternoon, guys. How are you?

Adam Foroughi, CEO and Co-Founder

Good. How are you, Jason?

Matt Stumpf, CFO

Hey, Jason.

Jason Bazinet, Analyst

I have a quick question, maybe two parts. Regarding the guidance for next quarter, it seems to imply a 3% to 5% sequential growth rate, which appears to be slower than your aspirations for the mobile-only segment of the business. Perhaps I'm misunderstanding something or there are other factors at play. That's the first part of my question. The second part is, I reviewed your historical financials and noticed there have been some quarters with sequential declines in ad revenue that ultimately did not reflect your overall growth potential. Should investors prepare for the possibility of a sequential decline in ad revenue in the future, even if it doesn’t change the overall outlook? Those are my two questions. I think it was 2022 when this occurred.

Adam Foroughi, CEO and Co-Founder

Yeah. So, I can answer the second part, and Matt can jump in if he wants to on guidance. But, Jason, 2022 was a lot different. It was pre-Axon model. And since we've released it, we've obviously seen an immense amount of growth. This thing continues to get better as it scales. And you get a really strong flywheel embedded into this type of a machine learning model. As we get more impressions, more engagements with the ads, more conversions, the system just continues to get smarter and smarter. And then, you pair that self-learning with the technological gains that our team continues to layer on top, and the growth of the business has obviously been phenomenal since. So, I wouldn't look back at '22 and before. Then, to your first question, the other thing you got in our business is in terms of seasonality, we have a bit of a unique advertising business because you typically expect Q1 to be a worse season. And our seasons are tied to time spent on mobile devices, and Q1 gets the benefit of a whole bunch of holiday days at the beginning of the quarter, and then you've got other things like Ramadan, and spring break that take effect in Q1. Q2, you actually don't have almost anything as only the tail end gets into summer. Q3, you get summer. Q4, you get the holidays. So, if you look last year at our quarter-over-quarter sequential growth, the only single-digit quarter was Q2. Now, we've said we're looking to grow 20% to 30%, but there's a whole bunch of unpredictable reasons why every year we think the growth could actually be materially higher. We almost grew 20% quarter-over-quarter in a single quarter in Q1 over Q4 if you normalize by day. So, the business is growing really quickly. We continue to see a lot of excitement from advertisers on the platform. They're spending more than they've ever spent before on the platform both across games and the web advertising initiative. And then, even more exciting, I touched on this in the talk script, we're finally going to be releasing our new dashboard to some select advertisers for feedback this quarter. That's a huge catalyzing effect. When we do go to a full self-service state, we're going to open up our platform from a very small amount of advertiser penetration to the entirety of the world being able to come on to our platform. Now, there's a lot to do between here and there, but once we do that, again, we'll go through another one of those transformational moments where the business will just change a lot. So, the past in our business isn't really indicative of the future growth trends because we just haven't been at a stable place yet.

Jason Bazinet, Analyst

Okay. Thank you.

Matthew Cost, Analyst

Hey, everybody. Thanks for taking the questions. Maybe I'll start off just talking about category exposure. I think last quarter, you highlighted a couple of new categories, including fintech and healthcare and insurance that you're having success moving into. So, I guess, are you continuing to push into new categories beyond the ones that you've talked about? And then, when you're having those conversations with new types of advertisers, what are the pain points that they're looking to have solved? Is it about onboarding those attribution partners? Is it about self-serve? And then, I have one follow-up. Thank you.

Adam Foroughi, CEO and Co-Founder

Yeah. So, I would say, Matt, we're not looking to push into any category of web advertising right now. We've got a line out the door of customers that have been waiting to come on to the platform, and then we've onboarded, I think I said, in a blog, hundreds of advertisers, but our team is small. So, when I say we're not looking to push, we're looking to push over time, but we need to get the self-service tools into the market so that we can pair that with the team to automate a lot more of the processes. What we're excited about today is the model is still in infancy when it comes to web advertising. We think it can get a lot better. And then, you layer on those attribution integrations and platform integrations to make the integration with advertisers more seamless. Both those two things, the automated tools, better integrations, paired with a much better model, which our model is inevitably going to get better as the engineering team has more time to evolve it, we think we're going to get to a place in web advertising where we are in games. Today, if you're a game advertiser, we're the best destination in the world to spend money. Every type of game, regardless of whether it launches today or launched years ago in any category, plugs into our system, puts in a return on ad spend goal, and scales at their goals. We're not there yet on web across categories, but we're seeing better performance than we expected this early. We're going to get there. And when we get there and we pair that with the self-service dashboard and launch that product globally, you're going to have an effect that catalyzes a ton of long-term growth.

Matthew Cost, Analyst

Great. Thank you. And then, I think, you mentioned in the prepared remarks something about automated ad creation. So, is that essentially tailored creative? And if so, what is the cost benefit analysis given the cost of generating creative for advertisers in real time?

Adam Foroughi, CEO and Co-Founder

Yeah. I mean, to answer the second part first, we don't know the cost benefit until we do it. But what we want to do is generative AI-based ad creative. And if you think about the platform today, we serve over 1 billion daily active users. We're serving a lot of impressions. But if you take a single advertiser, say, Activision with Candy Crush, they upload 20 static videos, let's say, for their campaign. And that's what their team can go create to run on our platform. And those videos go and serve, and they drive a certain response rate. Well, in the world of large language models and customization, we're not going to get to the extreme where every single end user can see a differentiated video, but we can certainly get to a place where you can take the best videos that an advertiser uploads, run them through a large language model, get an output of more videos that are dynamically generated, run those videos through our platform, let the model then personalize the ad to the end user at a greater level. When you're able to test ad creative, it's one of the biggest levers that advertisers have to move the needle on growth and response rate. It's effectively free; it’s a very low cost amount of production to get a much higher response rate on advertising. If we can systematically do it, and we're certain we can, it's just taking time to get this to market, we're going to be able to extract a lot higher response rate from the audience that sees the advertisements. And again, every time we have one of those events, it creates both a short-term step-up in growth, and then that compounds over time because the system then starts getting more transactions through it, it learns better, and it continues to build on itself. So, that's another one of those events that we think are going to be very impactful, and it's something that's a priority for us to work on across the rest of the year.

Matthew Cost, Analyst

Great. Thank you both.

Omar Dessouky, Analyst

Hi. Thank you for taking my question. Now that e-commerce has been scaled for a couple of quarters, I was curious if you have any updated insights on churn among your advertisers. Are you experiencing any churn, and what are your future assumptions regarding churn? Additionally, are you noticing an increase in spend per advertiser over the months, or is that spending primarily influenced by seasonal trends?

Adam Foroughi, CEO and Co-Founder

Yeah. So, we disclosed to you, Omar, I think I said 600-some-odd advertisers in the blog, $1 billion run rate. In terms of churn and web spend growth quarter-over-quarter, a comparison against Q4 versus Q1 isn't particularly fair in shopping, so I'm not going to disclose growth by advertiser. But when we think about churn with where we are in the advertising product for web, we're early. So inevitably, we're going to have some customers where it doesn't work for. Now, actually, right before this call, we pulled the number. For advertisers that spent a run rate of $250,000 a year, we had sub 3% churn. So, very little. Now, that's not an acceptable number for us. In gaming, we have basically no churn. Unless a game is not marketable and it's going to go out of business, companies in gaming do not drop off our platform. We're basically a requirement to their success. We want to be that in web advertising as well, but again, remember this product is months old. As the model gets better, we think we're going to be a destination for any type of advertiser that has a website or an app or both to come market themselves and have success where we become a required marketing destination for them and their business.

Omar Dessouky, Analyst

Okay. And if I could just ask a quick follow-up on a different topic? You disclosed 49%, year-on-year growth in net revenue per install. However, your e-commerce advertisers don't drive installs; they drive actions. So, is that metric inclusive of the actions that are driven by e-commerce?

Matt Stumpf, CFO

No, it's not, Omar. So, it's inclusive of the revenue associated with those web-based advertisers, but that's driving then an increase in the net revenue per install because the installation volume in that metric is staying stagnant, right? It's only based on the CPI-based advertisers.

Omar Dessouky, Analyst

Thank you very much.

Matt Stumpf, CFO

You're welcome.

Chris Kuntarich, Analyst

Thanks for taking my question. Adam, you mentioned that advertising could be better for some of the advertisers on the web-based experience. Curious if there's kind of a common thread that you would identify across those advertisers that we should be thinking about and some of the progress you could be making as we look forward into Q2 and later this year for just kind of road signs of progress for those advertisers.

Adam Foroughi, CEO and Co-Founder

Yeah. I wouldn't say it's trends or anything specific because it's just not the way the models work. But if you think back a couple of years ago on the game advertising call, pre-Axon 2 and what happened when we released the new version of the technology and what's built, the customers get better return on ad spend and more scale. Every time the model becomes more predictive, that's what happens. So, I sort of rate us as, like, a B+ right now with where we are. For how little time we've had in the market with the web-based model, it's performing really well, but we think it could perform a lot better. Now, games have grown a ton over the last couple of years. I don't know exact number, but I think I put in the blog. Ad spend on the platform has roughly quadrupled since we rolled out Axon 2. Now, that happens because you have better return on ad spend and better scale because the model evolves and gets better. So, if we get to a place where tomorrow, one of our engineers release a new version of the web model that's 30%, 40% better, I wouldn't be surprised. That doesn't mean that return on ad spend is 30%, 40% better because usually we achieve an advertiser's return on ad spend goals, but it means at the comparable return on ad spend, they get 30%, 40% more scale. Then that starts compounding, but that ends up universal on the platform.

Chris Kuntarich, Analyst

Got it. And maybe just one follow-up. As we talk to advertisers, one of the common feedbacks we hear is the desire to have exclusionary audiences. Curious kind of if you're thinking around offering that to your advertisers, specifically on the web-based side, has evolved since we've last spoke.

Adam Foroughi, CEO and Co-Founder

This is an interesting offering because it relates to how advertisers are accustomed to purchasing on Meta's platforms. Generally, advertisers provide an exclusion list and indicate that they want to target new audiences with a certain percentage of their budget instead of retargeting. We view our product as still being in the early stages, so our primary measure of success is our ability to scale while meeting return on ad spend expectations. This isn't about segmenting audiences but rather enhancing our matching model. Over time, we might introduce features like exclusionary targeting, and we've tested some of this in recent months, but it's not our main focus at this point since the product is still developing. If our product continues to perform well, we've already onboarded hundreds of advertisers to a $1 billion run rate, and I noted that we are currently under 0.1% market penetration. So, even though we are in the early stages and have faced challenges with some advertisers, we can see that opening the platform would lead to significant growth and success with many advertisers. While we aspire to help each advertiser succeed, we don't measure ourselves by how closely we mimic existing products; our goal is to create improved offerings for our advertisers. We consider feedback carefully, but we remain committed to our own strategy of enhancing the model to deliver the best results for advertisers.

James Heaney, Analyst

Great. Thank you, guys. Just it'd be great to get an update on the velocity of new web advertiser additions in the quarter. Just interested to hear how the pace has changed since you last reported 600 customers in December. And anything around how to think about that going into Q2 and second half of the year? And then, I had a follow-up.

Adam Foroughi, CEO and Co-Founder

Yeah. So, pace has slowed down because we just don't have the resources. So, the team is still about 20 people. So, if you think about, like, what a team consists of, there's sales, engineering, integration people, business development analysts at sales. So, there are not a lot of people in any one of those groups across this team. The objective right now is to give them the self-service dashboard, the automated tooling, so then they could start onboarding at the pace that they were able to do to get up to the 600-and-change. And I'm sure we're above that at this point, but the reality is we don't have the manual resources to onboard the line out the door, but we're there now with the dashboard that can really help the team. We're going to be in testing with it. We'll get early feedback. It looks quite good to us, and we believe it'll be quite good for the advertisers. Once we get that in the hands of advertisers where they can manually automate however they work with us, then the team is going to be able to onboard a lot more quickly. And so, you'll start seeing phases of how we roll this out. You'll hear about it on Twitter, I'm sure, with people playing around with the new dashboard and then us getting it into the hands of the advertiser base this quarter. And then, in the coming quarters, we'll start opening it up more and more, and that'll really help onboarding of advertisers to the point where, eventually, we will completely open it up, go global with the product, and then start really onboarding at a quick rate.

James Heaney, Analyst

And then, just as another question, we've heard from a lot of your e-commerce advertisers that the web product works really well for advertisers that optimize for those 24-hour conversion windows. I'd love to hear about any progress you're making with helping advertisers that have longer consideration windows and higher repeat purchases.

Adam Foroughi, CEO and Co-Founder

Well, look, we don't have a conversion API. We don't have what other companies have with email addresses and phone numbers. So, we can't attribute back anything outside of a cookie window. And the cookie window in this day and age, especially on Safari, is a very short window. What that means is that our model has to drive actions quickly. That's great for most advertisers. Most advertisers aren't selling a $20,000 product, but if you're selling a $20,000 product, you're probably not going to sell it in the matter of a few hours. So, on the one hand, because of our limited view on attribution, the model has to be really good at going from ad to transaction in a very short window. If you can do that for a $200 shirt, that's a great outcome because the advertiser knows the ad created actual intent and outcome. If that sale had happened two weeks later, it'd be very hard for the advertiser to say, I can justify the whole value of that sale back to the AppLovin channel because there's been a whole bunch of other things that have happened in the middle there. What that does force us to do though is have a challenge when it comes to an advertiser that's selling a much more expensive product. We probably have to go and optimize for that advertiser to something earlier in the funnel, maybe a phone call, maybe an email registration, but not all the way to the point of transaction if those transactions are basically impossible to drive in a matter of a few hours. Again, I remind you we have hundreds of advertisers into this thing. So, the world of advertisers here is so big. Most sell products pretty quickly. So, this honestly isn't something that we're even thinking about right now because we have a lot of room to go get advertisers and grow this business before we get to the constraint of, okay, now we have to make the product sell that are in the thousands or tens of thousands of dollars per product.

James Heaney, Analyst

That's great. Thank you.

Adam Foroughi, CEO and Co-Founder

Yeah.

Ralph Schackart, Analyst

Good afternoon. Thanks for taking the question, Adam and Matt. Just a question on self-service model. When you go live with that, obviously, you're testing right now, how do you expect the platform to sort of respond? Or maybe a better question is the advertisers, do you expect them to come with substantial budgets that you describe a line out the door? Do you think it'd be more like a dimmer switch where they would test and then add more budgets? Just trying to understand your best thoughts on what happens when you go live there.

Adam Foroughi, CEO and Co-Founder

Yeah. Look, advertisers need to prove to themselves that the dollars are worth spending. So, no one just comes and floods a new system. They usually build up budget over the weeks and months that they're live once they see that a campaign is actually achieving the goals that they have. Now, remember, we've constrained the audience in web advertising to US-only. That's by design. Our business itself is probably, I want to say off top of my head, half-half US versus international. We don't operate inside China. So, there's a lot of opportunity to just flip that switch and go global. Now, we'll pair the self-service dashboard with that. That'll allow us to really quickly, dramatically increase the audience that sees these kinds of ads and pair it with the types of advertisers and count of advertisers that are onboarding into the system. Then, it's up to them to find their own way. The good news is we're the last big advertising company that has a self-service dashboard. All the other ones, the social company, search, any display channel that's of any sort of scale has this type of ads manager product. Once we release it, agencies and advertisers will know what to do.

Ralph Schackart, Analyst

Great. Maybe a question for Matt. Matt, I think, historically you've talked about the growth algorithm being around 20% or 30%. Obviously, the business is growing very robustly. Is that still the right sort of framing for the model? Just kind of curious on your thoughts there.

Matt Stumpf, CFO

Yeah. I mean, we continue to believe that 20% to 30% is the right long-term growth rate for the company. As we've talked about before, that's comprised of two components. One is the ongoing reinforcement learning, right, from the model just transacting and then teaching itself and improving over time. And that component we think is about kind of 3% to 5%, which is how we're guiding on a quarterly basis. That's the component that we know is very stable, very predictable. And so that's what we've included within our guidance. Above and beyond that are directed enhancements, right, models going from ChatGPT 3 to 4. Our engineering team are working on all the time. And when they launch a new model, those provide step function increases. And so, those increase the annual growth rate in addition roughly around 10% is what we've kind of seen thus far. But we've had a lot of those quarters luckily where the engineers have launched those model enhancements and we've seen those step function increases. So, we think that we should be able to do at least one of those step function increases per year going forward. And it's a relatively conservative assumption from our perspective given where we've performed thus far over the past couple of years since launching.

Ralph Schackart, Analyst

Okay. Great. Thanks, Adam. Thanks, Matt.

Rob Sanderson, Analyst

Thank you. Can you hear me this time?

Matt Stumpf, CFO

We can, Rob. Yeah.

Adam Foroughi, CEO and Co-Founder

Yeah.

Matthew Thornton, Analyst

Hey, Adam, Matt, David. Hope everyone's well. Good to see you guys. Maybe two if I could. I guess, first one, maybe for Adam. If we think about some of the next layer of initiatives, and what I'm getting at there is really the non-gaming app-to-app user acquisition as well as the dynamic personalized ad creative that you alluded to earlier, should we think of those as initiatives that could actually start to contribute in 2025, or should we think of those as more 2026-type initiatives? And then, just one quick housekeeping follow-up, Matt. I think you guys have talked about the non-gaming audience plus business maybe being 10%-plus of total advertising revenue this year. Is that still how you're thinking about that business for 2025?

Adam Foroughi, CEO and Co-Founder

Yeah. On the question on the new stuff that we're really prioritizing, I don't know if it's new, just an expansion of what we're working on. I said in the talk script that focus is for this year to execute on that list. If we do that well, we're set up to have a fantastic 2026. We're already on the way to have a fantastic 2025. I don't know of any other tech company with the financial profile that we have and scale growing the way we are. I think it's on a rule of 150 or something. And what we're focused on when we talk about priorities is how's 2026 going to be? How's '27 going to be? If we execute on self-service dashboard, put it out in the market, automate media buying on our platform, make it simple for advertisers of any kind, let them come in, put in their goals, off they go, the business is going to have many quarters and years ahead of it of immense growth. At some point, we're going to become a marketing-based business. We can run AppLovin ads for any sort of small business to come in and buy on us, and you'll have an LTV to CAC model because the value of every one of those advertisers given where we're starting in advertiser penetration to the millions that we can go after would be immense. And then, pair that with dynamic ad creative continued model improvement, the self-learning in the system, and we've got a lot of vectors of growth that we're really excited about for the rest of the year and then beyond.

Matt Stumpf, CFO

And in terms of web-based advertising contribution, Matt, and we had mentioned previously, right, that we thought that they would become kind of 10% of the overall contribution in revenue. It's very difficult to guess where that might go within the year because we've got a lot of factors, right, on both the existing mobile gaming business, how that develops over time based on these model enhancements that we're launching. To the extent that we launched significant model enhancements, that business could grow at a faster pace than e-commerce, but we're very optimistic about the e-commerce business. After we launched the self-serve model, that business could grow quite significantly and outpace that 10% metric that we provided previously. So, it's quite likely that it could represent a larger than 10% portion of the revenue this year.

Matthew Thornton, Analyst

Great. Appreciate it. Thanks, guys.

Unidentified Analyst, Analyst

Hello. Good afternoon. Matt, regarding your earlier comments, I recall that last year we experienced two quarters with what I believe is referred to as human-directed enhancements, specifically in Q1 and Q3. Am I correct in understanding that this can occur even three, four, or five years into Axon 2? It's not dependent on the machine's life stage, but rather on its continuous learning? Additionally, could you clarify whether the learning applied to gaming and e-commerce is the same, or are these two different processes that may occur independently in a given quarter, where e-commerce might improve while gaming does not?

Matt Stumpf, CFO

Those are great questions. I'll start with the second one. There are two separate models, both of which are learning simultaneously. Reinforcement learning is happening for both models, and there are also directed enhancements that the team can implement on either model. We have a lean team that works on both models concurrently, similar to what Adam mentioned about our business development team. They are continuously testing potential changes to the models that could be launched at any time to achieve significant improvements. For example, the existing mobile gaming model might see improvements in one quarter, while the e-commerce model could focus solely on reinforcement learning and more stable growth, along with the addition of new advertisers, which will likely increase at a faster rate than the mobile gaming side does, as we currently have all mobile gaming advertisers. So, these two processes are progressing independently.

Adam Foroughi, CEO and Co-Founder

I would also like to add a few points. It's important to remember that our understanding of how to work with neural networks is still relatively new. We've all had the chance to experiment with it through tools like ChatGPT. The rapid pace of model releases reflects significant research in the field, which helps engineers at various companies refine their models and create new iterations. As we develop these new versions and train them on data, improvements in predictive capabilities will lead to advancements. The strength of our business model lies in being at the forefront of this research, having developed an outstanding implementation of this technology. We are likely among the best examples of how software can leverage value from the AI revolution. However, it's essential to recognize that we are still in the early stages. There is an extensive amount of research that our team needs to evaluate, alongside our internal studies. This is an ongoing process with no foreseeable conclusion for human involvement in these AI technologies, given the immense opportunity it presents. Therefore, we may want to consider calling it the Axon model rather than Axon 2, as we will see various iterations over the coming quarters and years. Each significant lift we achieve could warrant a new designation, but for now, we might refer to them incrementally, such as Axon 2.2, 2.3, and 2.4—these incremental advancements have demonstrated double-digit growth in some quarters. While there are also smaller enhancements that significantly impact our business, they may not show the same level of immediate lift. Our team has an extensive pipeline of development work ahead, and we anticipate that our research team will continuously enhance this model indefinitely.

Unidentified Analyst, Analyst

So, very quick follow-up. So, in simple terms, what Matt was saying that these are two different models, right? So, is it possible that you have Axon 2 running, and then there is a '22 level of event that happens with the e-commerce model, right, and it steps up in efficiency, and they will be not synchronized, but improving at a step function at different? Is that what you're saying?

Adam Foroughi, CEO and Co-Founder

The reason I keep emphasizing that the e-commerce model is still in its early stages is because, unlike when we launched Axon 2 for gaming, where we had gone through many iterations, the e-commerce model has only been operational for a few quarters. It hasn't been around long enough to establish a significant data feedback loop, as there are fewer impressions and transactions to learn from. Therefore, there are two strong levers that are set to come into play.

Clark Lampen, Analyst

Hey, guys. Good evening. Thanks for taking the question. Adam, as we are sifting through sort of Q1 performance for the Advertising segment within the sort of 20%-ish sequential growth that you referenced, I'm curious if that sort of as Matt put it before, did that include some benefit from step function rather than sort of reinforcement learning type improvements, i.e., sequential growth for gaming was probably ahead of the typical low- to mid-single-digits rate of growth?

Adam Foroughi, CEO and Co-Founder

Yeah, for sure. So, look, you have two less days. Q1, even though it's a good season with some of those holiday days, it's not compared to Q4, a good season. So, it was a huge step-up quarter. I mean, again, we might be the fastest-growing tech company anywhere at the scale that we operate at. So, there had to be multiple drivers there. And I mentioned on the talk script that there was better efficiency in the model. So, the team is constantly improving the model. Now, we don't call it, like, what would self-directed lift or a model change. This wasn't a material change to the model, but the team found wins in the model and it became more effective. Self-learning is an aspect of it. And I did say the advertiser contribution from e-comm getting a full quarter of the run rate that it had gotten to in Q4 was also impactful. And I think I said it was less impactful than the gaming side. So with that, you can infer that greater than 50% of the quarter's growth came from the gaming side. There's still a lot of room to go there. I mean, these advertisers, when we become the channel that they depend on, both the advertisers and the publishers need us to do our job. We're doing it very effectively, but we're still at a very low conversion rate per thousand impressions to where we think we can get to even in the gaming category. And so, the technology is still early. We're going to find more lifts. The team has got a long pipeline. So, we're really excited about both opportunity for the model to keep getting better in that flywheel effect because the scale has gotten so big, paired with what the team is going to be able to unlock as they make the model better.

Clark Lampen, Analyst

Okay. That makes a lot of sense, and it's helpful information. For my second question, can I ask a quick housekeeping one? Does the guidance for the second quarter include any upside or recognition from legacy studio spending? I recall that previously you mentioned a total software transaction value metric, and for accounting purposes, revenue from first-party studios wasn't recorded. Now that they are third-party, I would assume there may be some transition as long as they remain active. Is that reflected in the numbers, or is it significant at this point?

Matt Stumpf, CFO

Yeah. So, after signing the agreement today with Tripledot to divest the Apps business, our expectation is that the transaction is going to close towards the end of the quarter, actually, Clark. So, within the guidance, we have not assumed any incremental uplift from having those studios be external parties and the premium rate on the user acquisition cost that we would normally charge. That being said, it'll obviously depend on how Tripledot runs those businesses as to whether or not they will continue to spend at the same level. And it's not a material impact on the business one way or the other. It's a nice premium to have, but we don't expect that it'll move the needle.

Clark Lampen, Analyst

Thank you, guys.

Alec Brondolo, Analyst

Hey. Thanks so much. Adam, if you can maybe elaborate on the App Store regulatory news, some of the fee relief that mobile games might enjoy as we move through the year? I guess, one, how do you think about the potential impact on the business from an ad spend perspective? And then, two, how do you think about positioning the business to maybe assist in that transition, position yourself best to win some of that incremental spend to the extent that it materializes? Thanks.

Adam Foroughi, CEO and Co-Founder

We are currently the largest platform for mobile gaming customers to spend their money, and we believe we are the optimal choice for this. As a result, we are likely to benefit the most from any changes going forward. To put it simply, let's say the fee is reduced to 15%. If a mobile game developer previously charged a consumer $1 and received $0.70, under the new fee structure, they would now keep $0.85, resulting in a 20% increase in their revenue. A portion of that increase will likely be reinvested into advertising on our platform, which scales effectively. We operate a dynamic auction system, so if one customer wants to increase their bid due to their higher profits, others will follow suit due to the competitive nature of the auction. Ultimately, this will be beneficial for the ecosystem, driving growth and enhancing the advertising businesses as more dollars flow into the marketplace, leading to more competitive bidding that benefits us and, in turn, our publishers and shareholders.

Alec Brondolo, Analyst

Perfect. Thanks so much.

Jim Callahan, Analyst

Hi. Thanks for taking the question. Big investor question we get is just your ability to sort of monetize a relatively, like, static base of inventory. Now that we're a couple quarters into sort of launching e-comm, would be curious your sort of thought or if that's changed at all.

Adam Foroughi, CEO and Co-Founder

Well, look, we have a very large scale static base of inventory. I'd say if you look at Meta's business or YouTube, these are static bases of inventory. It's not like there are new users pouring in, especially in the States. But what's happening across the companies that are doing well in performance advertising is the matching and the technology algorithm is getting stronger. We're starting at a very, very low place. I think in the past, we've said, look, we're driving a 1% transaction right now. We've grown a lot, so that's probably gone up a little bit. Doesn't have to go up a lot for our business to expand dramatically. We think that can go up to become 2%, 3%, 4%, 5% over time. The ads are very, very impactful. It's full-screen video. It captures the user's attention. And the more advertiser demand we get as we open up our self-service platform and hopefully bring on thousands, tens of thousands, eventually hundreds of thousands of millions of customers, we're going to have more content to show the end consumer. We're going to pair that with personalized ad creative. The consumer response is going to go up. That's going to help us. It's going to help our publishers. It's going to help our partners, and we think it's going to catalyze potentially years and decades plus of growth.

Jim Callahan, Analyst

Got it. That is helpful. And then just quick one on gaming macro. Obviously, not really seeing any signs of weakness in the results, but anything to call out with regards to, like, the studio launches or geographies that are worth noting?

Adam Foroughi, CEO and Co-Founder

Our business is very diverse at this stage. One game alone would not significantly impact our overall operations. There have been larger launches or marketing efforts surrounding a few games, but this is consistent with our previous history of game launches. I don't believe the tariffs affect the digital economy in this context. Regarding economic slowdowns, free-to-play gaming remains a very affordable and accessible form of entertainment. Therefore, we believe it is quite resilient to economic fluctuations. We are confident in our market position.

Martin Yang, Analyst

Hi. Good afternoon. Thank you for taking my question. A couple question on the self-serve dashboard. First, has your view changed on who can have access first to the self-serve dashboard? Is it your existing customers primarily, or are you applying this to anyone regardless of their annual spend budget?

Adam Foroughi, CEO and Co-Founder

Yeah. We're going to roll it out in stages, Martin. So, right now, it's current customers. We'll have a feedback group. Once it gets past the feedback group, it'll open up to all current customers. The goal with that is to just help our team. The team right now is doing a bunch of manual labor, and we're capped, we're resource limited. So that's going to happen pretty quickly here over the coming weeks. I mean, I mentioned in my talk script. We're getting this in the hands of clients now. So that's going to be short-term. In the medium- to long-term, we'll go through stages of opening it up, where eventually long-term, and this isn't too long-term, but several quarters, we'll go completely open. But in between now and there, you'll have stages of opening it up to new types of clients so that we ensure the quality of client is high. The platform can be bug-free. It can work under all scenarios. The models have time to improve. We open it up, and off we go.

Eric Sheridan, Analyst

Thank you for taking the questions. I have two for you. Adam, I reviewed the blog post about TikTok, and I understand your labeling is somewhat of a long shot. However, it seems to me that your focus was more on the US ring-fenced process under the Trump administration, while the proposal discussed appears to be broader, affecting areas beyond China. I want to clarify the messaging in the blog and how it aligns with the current situation in DC regarding TikTok in the US and your positioning related to that. Matt, you continue to demonstrate a lot of efficiencies while growing at high rates. Do you have any updated insights on how you view incremental margins in the business over the medium to long term, or what you consider a steady-state rate for those margins? Thank you.

Adam Foroughi, CEO and Co-Founder

Yeah. Thanks, Eric. I don't want to spend too much time on TikTok, but just briefly, yes, we're going after the world outside of China. We think the biggest priority is to solve national security concerns with regards to biases in the algorithm and data in the US, but that's important outside of China everywhere. And to do that, you really truly do have to have operational control. Unless the US app is a separate app from the rest of the world, which it cannot be, would just deflate the app's productivity, then some company needs to have control to rewrite parts of the algorithm and to ensure that this thing complies with the standards around national security. We think our proposal is best suited to do that. In fact, we think we may be the only one who could do that with the knowledge that we have of models and the proposal we put forth. And on top of that, we think we would solve the present and be the best operator of this business long term through this type of partnership structure we propose. So, I put the thoughts out there. I wanted people to have context. It's absolutely a long shot. We do go after long shots. That shouldn't be surprising to our shareholders at this point. We think we've got the best performance advertising AI model the world has ever seen today, and that paired with an audience as large scale as TikTok could unlock immense economic potential and value for shareholders. So, it's something that we're excited about, and I put the rest of the details in the blog for others to read.

Matt Stumpf, CFO

And in terms of your second question, Eric, further the margin profile of the business and expectations going forward, I mean, as Adam mentioned, we continue to expect to run the business lean and it's part of the ethos of the company. So, as we continue to grow top-line, we're trying to find ways to do that in an efficient manner. Obviously, we've been talking about the self-serve platform. That's one obvious way that we're planning to grow by not adding any to the cost base. So, we do expect that the primary components of the cost base should remain relatively flat with obviously the exception of data center costs, which are more variable. What we've seen thus far as we grow revenue is that we've been adding on data center costs on an annual basis at least around kind of a 10% of the overall revenue growth, and we expect that that should continue. So, the margin profile of the business should continue to grow from where we're at today on the advertising business, up to that kind of asymptote, and then we'll see where we can take it from there.

Rob Sanderson, Analyst

Thank you. Can you hear me this time?

Matt Stumpf, CFO

We can, Rob. Yeah.

Adam Foroughi, CEO and Co-Founder

Yeah.

Matthew Thornton, Analyst

Adam Foroughi, CEO and Co-Founder

Yeah. On the question on the new stuff that we're really prioritizing, I don't know if it's new, just expansion of what we're working on. I said in the talk script that focus is for this year to execute on that list. If we do that well, we're set up to have a fantastic 2026. We're already on the way to have a fantastic 2025. I don't know of any other tech company with the financial profile that we have and scale growing the way we are. I think it's on a rule of 150 or something. And what we're focused on when we talk about priorities is how's 2026 going to be? How's '27 going to be? If we execute on self-service dashboard, put it out in the market, automate media buying on our platform, make it simple for advertisers of any kind, let them come in, put in their goals, off they go, the business is going to have many quarters and years ahead of it of immense growth. At some point, we're going to become a marketing-based business. We can run AppLovin ads for any sort of small business to come in and buy on us, and you'll have an LTV to CAC model because the value of every one of those advertisers given where we're starting in advertiser penetration to the millions that we can go after would be immense. And then, pair that with dynamic ad creative continued model improvement, the self-learning in the system, and we've got a lot of vectors of growth that we're really excited about for the rest of the year and then beyond.

Matt Stumpf, CFO

Matthew Thornton, Analyst

Great. Appreciate it. Thanks, guys.

Unidentified Analyst, Analyst

Hello. Good afternoon. Matt, to follow up on your previous comments, I recall that last year we had two quarters with what I believe are termed human-directed enhancements. If I remember correctly, those were in Q1 and Q3. Are you saying that such enhancements can occur even three, four, or five years into Axon 2? It seems to be more about its ability to continuously learn rather than its life stage. Additionally, could you clarify whether the learning processes are the same for gaming and e-commerce, or if they operate differently, allowing e-commerce, for instance, to make advancements in one quarter while gaming does not?

Matt Stumpf, CFO

Those are great questions. I’ll start with the second one. There are two distinct models working separately, both learning simultaneously. Reinforcement learning is happening in both models, along with directed enhancements that the team can implement on either one. We have a lean team dedicated to both models, much like what Adam mentioned about our business development team. They are continuously testing potential changes which can be launched on either model to achieve significant improvements at any time. We implement those enhancements, so for instance, the existing mobile gaming model might see growth in one quarter, while the e-commerce model could experience reinforcement learning and stable growth, along with the addition of new advertisers, which will likely increase at a faster rate than the mobile gaming side, where we currently have all mobile gaming advertisers. Therefore, these two models are progressing independently.