Unity Software Inc. Q4 FY2020 Earnings Call

Thank you, and welcome, everyone, to Unity's financial results webcast. Today, we'll be highlighting our results for the fourth quarter and for the full fiscal year of 2020. With me on the call today is John Riccitiello, President, Chief Executive Officer and Executive Chairman; and Kim Jabal, Senior Vice President and Chief Financial Officer. Now one of our goals on this call is to help investors understand our business model, and we're going to try to do this in an efficient manner. So after the close, we published a shareholder letter with financial commentary and guidance. And on this call, we will begin with brief remarks from John. Then we will answer questions that we collected and consolidated from analysts and investors. And finally, time permitting, we'll have the last 10 minutes or so for panelists to ask additional questions. So let's go on to the safe harbor statement. And I'd like to remind participants that during this conference call, we will be making forward-looking statements, including our financial outlook for the first quarter and full year of fiscal 2021 as well as statements about goals, business outlook, expectations for future financial performance and similar items, all of which are subject to risks, uncertainties and assumptions. Now you can find more information about these risks and uncertainties in the Risk Factors section of our filings with the SEC at sec.gov. And we remind everyone that our actual results may differ, and we undertake no obligation to revise or update any forward-looking statements. We will also be discussing non-GAAP financial measures today. Reconciliations between our GAAP and non-GAAP financial results and discussion of limitations of our non-GAAP financial measures can be found in our earnings press release. With that, let me turn it over to John for some introductory remarks.

Thank you, Richard, and thanks for joining us today and for your continued support. We are pleased to share our fourth quarter and full year 2020 results. I hope you have had the chance to read our shareholder letter, where we highlighted the quarter's and year's achievements as well as our guidance for 2021. We hope you and your loved ones are safe and healthy during these challenging times. Our team at Unity, which is over 4,000 strong, sends these well wishes to our customers, partners, and the end users of products built with Unity. We believe we are in the early stages of a significant technology transition, where digital content is evolving from being primarily 2-dimensional to real-time 3D. Those familiar with the history of technology know that such revolutions require change agents. In the realm of real-time 3D, we are observing a positive feedback loop of innovation in both software and hardware. For instance, advancements in GPUs, 5G bandwidth, 4K displays, and new XR devices are making real-time 3D accessible from any endpoint. At Unity, our software development platform and services enable creators to build engaging real-time 3D applications and environments. We are privileged to be at the forefront of this new era and are investing to capitalize on the significant opportunities ahead. We recently announced a strong Q4 with revenues of $220 million, a 39% increase from the prior year, and total revenues for 2020 of $772 million, which represents a 43% growth compared to 2019. These strong results were driven by our team’s exceptional execution and ongoing innovation for our customers. Additionally, we acknowledge that the COVID-related tailwinds contributed about $25 million to our total revenues in 2020. In our shareholder letter, we shared statistics that highlight the growth of our ecosystem, including Unity's market share among the top 1,000 games, monthly app downloads built with Unity, and monthly active users engaging with Unity content. All of these metrics reached record highs, with our market share of the top 1,000 in 58 countries at 71%. Downloads averaged 5 billion per month in Q4, and monthly active users reached an average of 2.7 billion in Q4 2020. While these record results do not directly translate to revenue in every instance, they signify the strength of our franchise and the ecosystem we support. We are grateful that our amazing customers are achieving great success in the marketplace. At Unity, successful metrics and outcomes stem from one source: innovation. We continuously push the limits of innovation. In 2020, we introduced hundreds of enhancements to our core create platform, and our operate team assists studios in optimizing lifetime customer value through new services like game growth. We also upgraded and launched applications for our customers beyond gaming. For example, in December, we showcased Volkswagen's innovative use of our vertical application, Forma, to create an engaging virtual e-commerce showroom. We are laying the groundwork for a future where most of the world’s content will eventually be in real-time 3D. Today, we are providing our guidance for 2021, projecting revenues between $950 million and $970 million for the year. This guidance accounts for multiple factors, including an underlying revenue growth of over 30%, which is our long-term objective; recognition that 2020’s revenue was somewhat elevated due to COVID-related factors; and the anticipated one-time hit of around $30 million to revenues or just over 3% in 2021 as advertisers adjust to Apple’s new IDFA approach. We are excited for a strong 2021, knowing that all of this would not be possible without our incredible, dedicated, and innovative employees at Unity. It is an honor for me to be part of this outstanding team. Now, I will turn this over to the operator, Kim, and Richard, and we will take questions.

Great. Thanks very much. Well, let's begin with a question about IDFA. Kim, would you like to start us off on that? The question is regarding any updates on the expected timing for IDFA changes related to iOS 14, and what impact those changes might have on our business, as well as whether that has been considered in our guidance.

Thank you for joining us today. Regarding IDFA, this is a question we received from all of you. The changes related to IDFA will require our customers to adjust their acquisition, monetization, and marketing strategies. We have been working closely with our customers to assist them in this process, and we have been preparing for quite some time. We are utilizing our insights from GDPR and our contextual advertising product, which does not depend on IDFA. We are also making efforts to minimize the risk to both Unity and our customers. As mentioned in our earnings release, we estimate that the IDFA changes will affect our revenue by approximately $30 million this year, assuming a rollout in the spring. While this estimate is not completely precise, we have detailed models to help us forecast the impact. We analyze data from each country, including impression levels for iOS versus Android, current and historical opt-out rates, the adoption rates of our contextual ad products, and our experience with GDPR. Therefore, we feel quite confident in our estimates.

I'd like to add a little perspective because I know this is a really important question in the mind of many investors. When we do a forecast, we're very analytical at Unity. For example, when we're trying to estimate revenue for, say, create seats, we'll look at a customer level, an individual publisher. We'll look at how many teams are using our product, how many people on each team, the job classification for each person on the team that might or might not use Unity, individual features that help us understand what the uptake rate can be across those classification of users on a by-team basis. And it's on that basis that we formulate an aggregated forecast of the business. It's not entirely science, but it's really close. We're even better at that when it comes to the monetization and services side because we have a lot more data. In this case, I just wanted to give you a couple of highlights, just to let you know. We did build our model up in a very detailed way. We have a handle on this. Point to start with in the beginning of the model is only about 30% of our impressions are from iOS. In many of these, a significant portion have already opted out for limited ad tracking. So we take data like that. We take information, extreme detail on our experience with opt-outs when people are presented with new user flows for a game or other application, and we build it up step by step. We have a good understanding. Now we don't know if advertisers are going to respond with incremental advertising spend to drive installs. That's a possibility. We can't quite get every last nuance from this, nor can we understand precisely what our market share offset will be, but we feel confident that we're growing our advertising business with market share growth that's been going on for many years on the basis of strong data insights. So net-net, it's an estimate, but we're not guessing. We've got a very detailed model in place, and we think we understand where we're going.

Great. Thanks. So the second question is the thing that all of us had to deal with this year is about COVID, and about half the analysts ask this, but Bhavan Suri asked first, so he gets the shout-out. So Kim, the question is, is how did COVID impact your 2020 results? And more importantly, how are you thinking about the impact kind of, of a normalized environment on gaming as COVID recedes? And then more broadly, what is the impact you see from COVID on your overall business, particularly beyond gaming?

Sure. So as you saw in our earnings release, we called out a net $25 million of upside to revenue because of COVID, alongside $40 million in net expense savings after some reinvestment. We see less of an impact in 2021 related to COVID. On the revenue side, we're entering the year with lots of momentum across both gaming and new verticals. In gaming, we gained share in a market that experienced a trifecta of user engagement. We had new gamers entering the market. We had lapsed gamers coming back, and we had existing gamers playing a lot more often. And so as a result, as John mentioned, as you saw in our release, our monthly active users who consumed content created or operated with Unity reached an average of 2.7 billion per month in Q4, and that's up 63% year-over-year. And interestingly, new players we gained in 2020 had a 27% higher rate of in-app purchase versus existing users. So these are new valuable users that are coming into the ecosystem. And for 2021, our view is that this momentum in user engagement will continue even as the world hopefully starts returning to normal. Historically, this is what we've seen in the gaming industry, which is growing faster and is now larger than the film and music industries combined. And we believe this is because a game is so much more interactive. You control the character. The next frame is something nobody's ever seen. And now with the increasing levels of network-based connectivity, you're also engaging with other players, with your friends. So we see a lot of momentum heading into 2021 in gaming. In new verticals, our year started out slowly in 2020 as companies adjusted to working in a COVID environment, but we ended really strong and have great momentum heading into 2021. In Q4, of our 793 customers with revenue over $100,000 a year, 13% of those were driving revenue for us outside of gaming. And this is up from 8% just a couple of quarters ago when we filed our S-1. The other thing I would say on the expense side in 2021, we are assuming continued reductions in travel, facilities and marketing event spend, with some uptick by the end of the year. And we're generally, though, planning to reinvest those savings into headcount and initiatives that will drive revenue growth across R&D and sales and marketing. The last thing I'll note, an interesting dynamic from COVID is that it made hiring a bit more back-end-loaded for some of our teams, and the start dates for many of our Q4 hires flowed over into 2021. So we have a stronger-than-usual start for the year on our hiring. Over 3/4 of our projected headcount growth for Q1 is tied to offers that were accepted last quarter. So we have a really strong running start, and this is reflected in our Q1 guidance for a sequential drop in operating margin.

Great. Okay. Let's move on to kind of business highlights. So let's start with kind of create for verticals. The first question there is from Mario Lu at Barclays, and he asked, can you talk about Unity's Forma and what the opportunity set is for that product beyond kind of the virtual auto showrooms and into maybe e-commerce site brands beyond Volkswagen?

Sure. Toward the end of last year, we introduced and launched Unity Forma. For those who may not be familiar with it, when a creator uses Unity, they are utilizing a highly powerful tool with numerous pull-down menus for content creation. There are hundreds of menus within the editor, making it easy for professional developers to navigate. However, for those who are not acquainted with real-time 3D content development, it can be quite challenging and may require a year or more to master. Our run-time applications bring this power to users, enabling them to accomplish their tasks with just 4 or 5 buttons. This makes it user-friendly, straightforward to implement, and facilitates onboarding new clients onto the platform. One of our initial tools, Reflect, has seen significant success in the architecture and construction sector, which we discussed in the previous call. Now focusing on Unity Forma, previous virtual showrooms or e-commerce experiences were limited to a handful of JPEGs or a video, which are inadequate. Unity Forma democratizes the creation of engaging real-time 3D environments for business users. We developed Forma to address the needs of manufacturers and consumer brands looking to produce interactive marketing content, including product configurators. We've highlighted Volkswagen's initiatives as a case study. Our early customers include a luxury goods manufacturer, an aerospace company, and a prominent hospitality chain. We are making substantial progress across various sectors, which helps onboard more users onto the Unity platform. Recently, we've welcomed Newell Brands, Walgreens, Liberte Productions, SHOWstudio, and Nick Knight, among others, to our platform to leverage tools like Forma and Reflect, with more to come.

Great. Okay. So staying on creating for verticals, Brent Bracelin of Piper Sandler asked about our go-to-market strategy in various verticals like manufacturing. He mentioned that in some markets it makes sense to operate independently, while in others it’s more effective to collaborate with channel partners or professional services companies. How are we approaching this strategy?

So the response really is, first off, it's a good question. Look, we try to start at the top, which means that we target kind of the most innovative companies in the sector. And so what they become is kind of beacons and reference customers when we shift from kind of a land to expand model in a particular vertical. Our go-to-market motion depends on kind of where the customer is in terms of embedding real-time 3D into their business model. So that really means kind of 3 components: direct sales, engage our own in-house professional services or kind of work with VARs and channel partners. So for example, on the direct front, we sell Reflect alongside Autodesk's AEC platform. With Esri, we are providing a joint go-to-market strategy with them, geospatial and 3D technology to the Department of Defense. With Continental Elektrobit, our work is focused on kind of in-car entertainment systems. But sometimes, customers need help standing up a project. So in that case, we either bring in our in-house specialists like Finger Foods, which we have as our internal group, or we tap a growing network of value-added resellers or managed delivery providers.

So let's go to the fifth question, back to John. So a couple of you had sent us questions about the recent hiring of Peter Moore. So maybe, John, you could talk about that new hire and any other announcements that we've made of late.

Sure. So we see the opportunity in front of us at Unity is massively significant. We think it's a once-in-a-generation opportunity, and we're a once-in-a-generation company. And we've signaled many times that we're investing to realize this opportunity. Now I'm really proud of the team at Unity. The team you saw in our S-1 and the IPO is, for the most part, the team that I brought on 5 and 6 years ago to take this company from the amazing start of the founders and a small team to what we are today. Now part of my job is to make sure that the leadership team has all the capacity and capability to realize the opportunity in front of us. And so from time to time, I'm a bit like a football or soccer coach; I make changes to win championships. And that's part of my job here at Unity. Now with Peter Moore, we see a significant opportunity in the arena of sports and live entertainment. We don't have specific announcements to make today. Many of you probably know, Peter is well storied in the industry, and he'll have some things to talk about in future calls. I think it's also worth noting, we announced internally today, but not externally, that will come in a couple of weeks, that we've hired Marc Whitten from Amazon to lead our Create Solutions business. Marc is an incredible leader in the world of tech and entertainment. He leads a large GM team in Amazon now. He's also essentially the founder of Xbox Live, there from the very beginning, both a large organization that realized everything that is Xbox Live. He brings a lot to Unity, and his leadership will add to our ability to grow and grow faster in the months and years to come. So there is always something going on at Unity, but in this instance, what we're trying to do is map to make sure that the opportunity is met with the ability to realize it.

Okay. So let's move on to create for gaming. John, you can take this one. So Ryan Gee at Bank of America Merrill Lynch asked, Cyberpunk 2077 was a high-profile launch that was unfortunately filled with bugs, but CD PROJEKT is far from the only studio that's faced this issue. So to what extent do you think this will be kind of a wake-up call, not just for AAA, but also pretty much everyone in the industry about whether or not to build bespoke game engines?

So this is my day-to-day life these days. Just as a background, I've been leading teams that build game engines going back to 1997 and been involved in the creation of DOTS and game engines, including leading the organization at the time that we created Frostbite at Electronic Arts. And I completely get the allure of creating new technology if you're a gaming company. But I think we've reached the point that it's probably a negative return on investment for most people to create their own technology. It's expensive. It's challenging to get to a number of platforms. And at times, it gets in the way of what consumers really want, which is great content, well-polished, well-finished, and bug-free. So at Unity, we've built a game engine, and it gives developers all the tools they need to create gameplay that works: auto realistic visuals on any endpoint and a full suite of monetization, content delivery, and hosting options through our operated services. As you've watched this, our market share across all platforms has been rising dramatically in recent years and, again, recent quarters. I think more publishers and developers are coming to realize the power of Unity. I think that will continue. I think there's a lot of love for shelf-built engines. And I think over time, we'll see a few of them.

Great. So going to note another one here for you, John. So Tom Roderick at Stifel asks, so on the create side, by our estimates, your addressable market, at least in terms of seat count for game artists, is approximately double that of gaming programmers. Could you update us on the progress you're making here with art engine? But more broadly on penetrating this market, what's the competitive set? Is this a replacement sale, add-on sale? And who makes the buying decision?

So for the most part, when we're closing new seats on chains, it's artists. And they come onto the platform in a pretty deliberate way. So the first thing we've been investing in is better workflows. So the Unity engine, the Unity editor is a lot more intuitive for users. And we've made great progress, but not much. What I mean by intuitive is when years have gone by, an artist would go to their programmer and say, 'Hey, I've created this amazing graphic. Can you import it into the game for me? Can you integrate it into the game? Can you help us build from these hard artifacts, the animation or other things?' In other words, Unity was too hard to use for them, as is any game engine. By enhancing the simplicity of the workflows, a lot of artists are able now to use Unity directly. The second thing we do is we create specific tools that enable a developer, the artist developer, to create directly in Unity without the complexity of invoking the more nuanced parts of the editor. These are tools like the VFX Graph, Shader Graph, and some of our environmental offerings. You can work directly with the editor, but the complexity is removed. So here, what we're doing, and ArtEngine is among these, giving them enormously powerful tools that sit on top of Unity, they can get more with less complexity. The last thing we're doing is we're working hard on specialized tools to really help an artist feel like they're chatting with us. Now ArtEngine is also part of this. But it's about allowing them to easily find, through the asset store or other services, assets that they can directly employ on the game without creating them from scratch and tools that they can use to transform those to be able to be directly used inside the game, so inside the application they're building. So we have a, if you will, a 3-front assault on helping developers, particularly artists, feel much more productive and be much more productive. One is workflows, make it simpler, the core engine. Other is tools to advance them without the complexity of the editor to be able to do things in a productive way. And third is to bring assets directly to them, so they're not starting from scratch. So if it were a baseball metaphor, they're starting on third base. And that's the notion, and that's why we're seeing a lot of growth in create tools.

Great. Thanks. All right. Well, let's pivot over to operate, just to operate for gaming. So John, Andrew Uerkwitz at Oppenheimer asked, one of the strengths of Unity is that you all have a lot of data that gives you differentiated insights into gamer behavior. You have a strong presence in the long tail of AA and single A developers. So the question is, how do you see the evolution of your market from monetization and back-end services with AAA studios?

So there's two things. First off, if you go back 4 and 5 years, Unity really wasn't a good choice for AAA studios to use for content creation. That's no longer true. And so that's one of the reasons we've seen so much market share growth in AA and AAA. And we now support Xbox and Sony PlayStation on launch date, and well before that, launch titles. So first, we had to have the basics in place to take the capability of in-mobile and then make it work just as well in AA and AAA. But one of the things to understand, AAA content is very engineering-centric, and there's a lot of engineers on the team. And with that comes a very justified mentality that I can build everything from scratch. I've seen developers that build their own ERP systems from scratch. And they do it because they're engineers. They always imagine they can do it better. What Unity gives them is really 2 things: increasing flexibility to start with Unity, again, put you on third base on content creation; and just as well, we bring them advantages. On the monetization side, as an example, some of our customers might have data on 20 million MAUs or 30 million or 50 million or even 100 million if they're at significant scale. As you heard, we're at 2.7 billion. The data advantage is very sizable and very important. So we bring tools to them, so increasingly, they don't have to create from scratch. Every time what they need, they can use Unity. And in the service side, we bring scale, both on the data side and the infrastructure side, that they can leverage. It's worth noting, some of the most important games, as they moved into online mode post-launch, they fell over. The products that were launched with Unity, Apex Legends and others, they had smooth scaling and successful launches on Unity's back-end. So it's a great question. And our path really has been mobile to AA to AAA on create. Now we're just getting into AAA on create in a more successful way. And operate is usually the echo, what's right behind it, and we're coming up fast.

Great. So we have a question on the recently announced Game Growth Program. I'll take that one. It's from Yao Chew and Brad Zelnick at Crédit Suisse. And the question is this: you announced Game Growth Program late last year. Can you talk about the origin of the concept? And what is your value proposition for indie developers?

This program is still in its early stages, but we are very excited about the Game Growth Program developed by the operate team. The concept emerged from our belief that many fantastic games, particularly in the indie sector, often do not receive the attention they deserve. Unity has always supported creators, and it didn't seem fair that they had to choose between realizing their creative vision and implementing strategies to attract audiences and generate revenue. Game Growth aims to leverage the best practices we have identified over the years, drawing from vast amounts of data collected from numerous applications and extensive testing conducted with our tools. We view this as a beneficial model for a select group of our customers, allowing them to concentrate on creating excellent games while we assist them in monetization with an improved revenue sharing model.

So let's go to the tenth question, and this is operate for verticals for John. So Brent Bracelin at Piper asked, how would you describe the opportunities to monetize non-gaming verticals within the operate system? It seems that Multiplay has applicability outside of gaming. So first off, is that a correct assumption? And more broadly, at a high level, how would you think about the drivers for this part of your business?

So first off, I would say that I'm truly excited about the opportunities for operate outside of gaming. Starting point, though, is most non-gaming applications you see today, whatever app you're using, they're not presently real-time 3D, and they're increasingly becoming real-time 3D. What we've done with products like Forma and Reflect is we've lowered the bar to take your application into the 21st century. If it's architecture or construction, we've got Reflect. If it's in many, many industries, where you might get involved with a configurator real-time 3D website, that's Forma. In both cases, by way of example, we also simplified the process not only for creating a site, but supporting the site with our own Furioos service for delivering real-time content to these new applications that are out there. Once an application is real-time 3D, it's no longer static. It needs data; it needs streaming; it needs support. And that's where we come in. If it's Multiplay, we can host it. If it needs content updates and content on a streaming basis, that's Furioos. We see a lot of opportunity in e-commerce, which is an area we're starting to focus on increasingly now. Again, if you're going to want to see a real-time 3D view of a dining table, customizing the wood or the hardware, those are the kinds of things you're going to need back-end support for. With Unity, it's literally just a check box. You don't need to bring in an engineering team to make it work. It's because of circumstances like that and many more that we feel really good about the operate opportunity outside of gaming.

Great. So let's shift our focus to R&D and core technology, John. Bhavan Suri at William Blair asked about a significant part of your competitive strategy being centered on R&D-led innovation. Could you discuss the progress you made in 2020 and your future direction, especially regarding some of the projects you have mentioned previously, such as NetCode and DOTS?

NetCode and DOTS are significant innovations at Unity, and I'll discuss them separately. NetCode is essential for developers to connect multiple players in a single game instance. It facilitates networking for different genres like RPGs, FPS, and sports games, ensuring that everyone plays in a synchronized environment. It’s important to note that the requirements for an FPS differ from those needed for developers at headquarters. For an FPS, even a 10-millisecond latency is critical, but in other applications like Reflect, it isn’t noticeable. In RPGs or puzzle games, the focus shifts to bandwidth; the challenge is streaming high-quality art and textures quickly. Each application requires a different approach to NetCode, and we have already launched some new products in this area, with plans to expand further this year, marking 2021 as the year of NetCode. Developing this is complex, and it’s something that many games have to build from scratch, which makes it difficult for developers. Our goal is to simplify this process, helping them successfully create multiplayer games while addressing issues like lag and cheating. We also integrate it directly with Multiplay, making it user-friendly within the Unity editor. DOTS, on the other hand, is our data-oriented technology stack, encouraging developers to rethink how data is structured. When I refer to data, I mean all game content, such as characters, art, scripts, environments, and physics. In traditional object-oriented programming, maximum performance is limited by how much can be processed by an individual core and GPU. By moving away from that model and segmenting data more efficiently, we can achieve 10 to 100 times better performance in complex environments with numerous interactive objects. Over the next few years, we plan to integrate easier-to-use versions of DOTS into our core technology, which provides sophisticated capabilities without requiring extensive effort from developers. I believe this approach represents the future direction for most games and significantly enhances the Unity technology offering.

Right. So we got an M&A question from Andrew Uerkwitz at Oppenheimer. So you acquired RestAR in mid-December, but you also, in the past, have made a series of tuck-in acquisitions. Today, you have a bit of a cash war chest, but as we know, sellers also have high valuation expectations. Could you just talk at least at high level how you think about M&A as a means to accelerate go-to-market strategies and your technology roadmap?

Yes, sure. So as a starting point, going back from the beginning, we spent approximately $300 million in M&A. It's not been a gigantic investment on our end. We've been acquiring companies mostly in an acquihire orientation to get capability that we think we want under the platform, and it's been mostly a build-versus-buy tuck-in orientation. Now this idea of a war chest, I'm a believer that most M&A is a bad idea. We've got really high hurdles for clearing on strategic criteria, tactical criteria, execution, culture. It's all got to match. So the bigger the price, the more hurdles we're going to put in front of it. Obviously, I don't have anything specific to say. I wouldn't rule something out. Our notion is that M&A, to get us something that we can't get another way cheaper or more effectively. I feel really good about what we've done so far when we do reviews for our Board on the M&A we've done so far. It's almost all worked and worked really well. I want to keep on that. But think of us as primarily organically oriented. But we look at things to take advantage of where we can go in the market.

Great. In my opinion, this is the best written question we've received from all of you. It's from Yao Chew and Brad Zelnick at Crédit Suisse. I had to read it word for word because it’s too good not to. John, you’re quite quotable when it comes to your comments on XR. I’m not sure which phrase I prefer, the gap of disappointment or analysts are idiots. As a former analyst, I appreciate that line. Anyway, what are your latest thoughts on the bear camp that believes if COVID didn’t highlight XR, nothing will, versus the bull camp that argues this time is different? What’s different today? What are the key developments in the landscape? And which platforms are you monitoring?

So my first presentations on XR at Unity go back 5 years. At the time, products like Oculus were winning CES and other awards. It was then that I was coming out with this gap of disappointment. What I was explaining is, in the market, a lot of the analysts were projecting this staggering growth, taking off really the next year or the year after that. And what I was explaining was that wasn't going to happen. The gap of disappointment was I expected much slower growth in the initial years. Successful consumer platforms need to meet a number of criteria. The hardware needs to work at the starting point. It needs to be simple. If it's as challenging as programming a VCR back in the day, it's not the kind of thing that's going to yield mass adoption. I can remember trying a number of these devices early on, and I'm pretty familiar with this space; it would take me hours to set it up and sometimes hours to get it going the second time. And I'm running around with a cable in the back of my head. That's not an easy thing to do. It also should have a consumer price that works. More than anything, people need to remember that people don't buy hardware for hardware; they buy hardware for what you can do with it, the software that you can play in it. So there needs to be a vibrant ecosystem of content. For that to work, you also need to have developer economics that bring people onto the platform. Those are a handful of criteria, and I haven't seen the combination yet where it's all brought together. Now Facebook has made really good progress with Quest 2. It's an impressive device. They've announced that more than 60 titles generated over $1 million revenue. But for people to develop content that's really going to be beautiful, $1 million doesn't cut it. It needs to be $100 million or multiple hundreds of millions. That will happen, I'm highly confident. Now think about this for a minute. I owned an early MP3 player well before the iPhone. That didn't make me think when I got that that low-penetration products that were produced by a number of manufacturers, that music wasn't going to make it to my pocket someday. I was pretty sure it was going to make it to my pocket someday, just that wasn't the right product. One of the big innovations from Apple and Steve Jobs was getting all the music publishers onto the Apple platform, which is what ignited the massive growth in that arena. The point that I'm making is simply this: I am highly confident that the experience is spectacular with XR devices I've seen. I am highly confident that the larger players that are operating in the ecosystem see what we see, and they're going to get it right. If I were to give that same presentation around the gap of disappointment that I gave 5 years ago with no real endpoint in sight for when all this was going to come together, I'd say I can start to see that it's going to come together. Thank you for all the early investors in XR to get it off the ground. You made the industry possible. I think now we're going to find that there's more opportunity in the years to come. I feel good about it. But it's still tomorrow for scale.

Great. Thanks. So we'll finish up with a couple of finance questions. So first, let's start for Kim. Tom Roderick at Stifel asked, can you provide some detail around which areas you're focusing your sales and marketing investments on between gaming and verticals? More broadly, how should we think about operating leverage versus revenue growth?

Sure. So thanks for the question. We see huge opportunities in both gaming and in new verticals. So we are definitely investing aggressively in both. Currently, the majority of our sales and marketing investments are still in gaming, particularly if you look across both create and operate. But we're actively growing our investment in other verticals, especially on the create side. As we did in gaming, we'll start with create and then expand to operate. John talked about some of the opportunities for other verticals within operate. So we built out a multichannel go-to-market model that enables us to push the right products through the right channels to optimize sales and marketing effectiveness. We have a direct sales team in addition to inside sales. We have a lower-cost sales development team. We have indirect reseller channels. We have strategic partnerships that enable demand generation. We have our online stores. So we're moving quickly to grow both in gaming and verticals with this approach. In terms of operating leverage, we're very focused on meeting our revenue goals and maintaining our gross margins so that we can both invest in future growth, revenue growth as well as increasing operating leverage. One thing I should point out that's important to understand is that if we exceed our revenue expectations, we will reinvest, in a disciplined way, the upside into revenue-driving initiatives rather than accelerating our path to profitability, which we hope to achieve on a free cash flow basis by the end of 2023.

Great. Thanks. So I'll take the last kind of tactical question. So Franco Granda at D.A. Davidson asked, so hey, you increased prices by about 20% on Pro/Plus tiers last January. What has been the reception of this pricing hike by users in the first year? How should we think about the percentage of accounts that now fall under the increased pricing plan in terms of upside for 2021?

So as you pointed out, yes, we raised prices just over a year ago, and the large majority of the price increases rolled through our numbers. Those factors are embedded in our guidance. Now for context, just so you know, we got very little pushback from our customers on the price increase. And that's a good sign because it says that our developers see a lot of value in our technology. Stepping back further, our view is that you earn your way to market leadership, and you do that by delivering better functionality at lower cost of ownership. So our goal right now is to focus on those factors rather than kind of getting some sort of short-term pop that we would get from raising prices.

Now we will begin the question and answer session. Let's open this up. The first person to ask a question will be Yao Chew at Crédit Suisse. Yes, there you are. Please go ahead.

Congrats on a great close to the year. In particular, thanks for helping break out the COVID and IDFA impacts. My question is on that $30 million, either John or Kim. Really wanted to double-click here in two parts. Number one, is this $30 million number consistent, worse or better, with the way you were thinking about approaching the situation 90 days ago? A lot has changed, and there's been a lot of new announcements from key players in this space. Just trying to understand the cadence and the approach to that. And second question is, how are you thinking about the shape of the recovery and the impact on that? Is this a one-year issue when most of it goes away by the end of the year? Or should this lag a little bit more into 2022 at this point?

John, do you want me to start, and you can jump in?

Sure.

Yes. I don't believe much has changed in our assessment of the impact. We had anticipated some effects in Q4, which were postponed. Overall, I wouldn’t say there have been significant developments in the past 90 days. We’ve been preparing for this for years and recognized the associated risk, so we have been ready for this moment. We have successfully navigated similar challenges with GDPR. I wouldn’t say anything has fundamentally changed recently. As mentioned earlier, we are confident in our business forecasting abilities. While there is some uncertainty introduced, we believe we can predict the impact on our business. Regarding the shape of the recovery, John, I'll let you address that. I will say there will be a short-term impact as advertisers adapt to the changes. We expect a notable effect this year, which is why we have disclosed the $30 million figure. However, we see a genuine opportunity for market share growth over time.

Yes, just to provide some additional insight, 2020 and 2021 had some unusual influences. The changes brought by IDFA are significant, and COVID has also had a major impact. Analyzing COVID shows that consumer behaviors have advanced more quickly than expected. We might experience some declines or a slowdown in engagement growth, but I don’t think it will affect us severely. Looking ahead to 2021, we may still be constrained at home for another six months, which is not ideal for any of us. We can draw some conclusions from China's experience, which gives us a valuable early indication. We don’t see anything particularly disruptive ahead. Regarding IDFA, while it is important and has generated a lot of discussion, we view it as one of three key factors. The first factor is the overall growth in the industry surrounding user acquisition and engagement. This growth is not going anywhere; the gaming industry is strong and expanding, and we are confident in that. Within this space, we’ve been increasing our market share thanks to our superior product and service. There is some shift caused by IDFA, but we have accounted for that. Its effect on our revenue is not substantial, and we feel assured that we are on the right path.

Great. Tom Roderick at Stifel, you're up next.

So congratulations, everybody. Great year, a lot to work through and fantastic finish. Kim, you noted, I think, the net dollar retention number was 138% for the year, and I was hoping you could kind of help us square that with some of the positive benefits you saw from COVID during the year. In other words, maybe give us sort of a level set for how that might play out in a normalized year. I know it's not a metric you necessarily guide to, but perhaps you could set the table for us without thinking about what some of the one-time benefits were this year in that number?

Yes, sure. So overall, NER has been a very strong metric for us. As you've seen, it's been well over 120% for the last two years. What we saw this year, if you look at the sequential trends, is in Q2 and Q3, we saw a pretty healthy jump in NER as the shelter-in-place orders drove that higher end-user engagement that we talked about. Within our Operate Solutions business, in particular, it really drove that metric in Q2 and Q3. What you see is it coming down a bit in Q4. Some of that had to do with a tough compare over Q4 '19 in which we had a more typical seasonal lift. We benefited from a number of product and algorithm enhancements within Operate Solutions. This is some of what's going on within that trend throughout the year. To answer your question, thinking about next year, we do expect that metric to moderate, particularly given those tailwinds that we had in 2020 and the impact of IDFA in 2021. So moderation, we expect that metric to have some volatility, but we really believe it will be a very strong metric for us as we just continue to see the growth within all of our customers across both create and operate.

Great. Franco Granda at D.A. Davidson.

I had two very quick ones, if I may. One for John and one for Kim. The first one for John, really. There's been a lot of questions about user engagement as we entered '21, right? There are two big trends that could potentially impact user engagement, particularly in the mobile side of things: one, obviously being COVID, which you talked about in detail; and then two, the launch of the new consoles. So my question really is on the latter. Have you seen a slowdown in engagement across your platform as a result of the new console launches? Or are the supply issues acting as a small benefit today since a lot of people haven't gotten their hands on one? And then really the second one for Kim. Can you break out what percentage of your total revenues are advertising revenues? And then perhaps if you do that, what are the margins associated with those?

The answer to that lengthy first question is no. You might want some additional details. As a starting point, when we look at monthly engagement, it's mostly mobile because most players around the world are on mobile. For context, when we combine all the consoles in a month, we estimate around 100 million players. These players are very engaged and tend to spend a lot of money, often $60 or even $70 for titles. Those players are very important to us. However, overall engagement exceeds 2.7 billion users, with most being mobile. I would say the launches of new consoles have a relatively minor impact. What generally occurs and is occurring now is that those who manage to get an Xbox or PlayStation, the latest generation of products from late last year, tend to shift from their old consoles to the new ones. There is definitely a noticeable increase in engagement from those users who obtain new hardware. But in the grand scheme of things, they represent only about 3% to 4% of the total user base, so only a small portion upgraded to the new hardware. What I anticipate happening, and I believe this is important, is that the console and PC market has been losing market share to mobile for some time, and typically when new consoles launch, there is a revival in console engagement, which I fully expect will occur. I'm eager to play more console games on the new devices. But no, we haven't observed any significant reduction in engagement.

Yes. In terms of the advertising revenue, so we don't break out our revenue by product. We have a mix of product and services within both create and operate. I can say that it is the largest piece of our Operate Solutions business, primarily because it was the first. We've been building that business for several years now. Some of the other products and services within operate are just relatively newer. It is a larger portion of that business, but we're not breaking it out. On the question around margins, that's also something we're not disclosing. We actually, as a company, don't really look at our margins by business line. We look at the total company margin. We do look at product-by-product margin profiles. We're not breaking that out, but I can say that when we look across all of our products and services, two of the highest gross margin products are our subscription product and our monetization service.

I want to add one last nuance on the engagement point. People buying higher-end phones definitely correlates to increased engagement in mobile gaming. Most people install more applications around new hardware. You've all done it. You get a new phone, you install a bunch of new stuff. The numbers on the new Samsung and the new Apple phones are orders of magnitude bigger than console launches in terms of user households. Don't forget that what we've just witnessed is not just in the world of console. It's also in the world of mobile.

Brent Bracelin at Piper Sandler, used to be Piper Jaffray, but now Piper Sandler.

Good seeing that team here. I had one question I wanted to kind of drill down into a little bit more. It's really around the beyond gaming segment and the momentum you saw there. I mean six months ago, this was, what, 8% of the create mix. It's now 13%. That puts it, by my math, on a year-over-year basis, close to triple-digit growth. So accelerating growth in kind of beyond gaming, why now? Is this a Forma, Reflect product bump one quarter? Is this auto configurations just taking off? Walk me through what are the drivers of this, that looks like, sharp inflection point around momentum for 3D beyond gaming.

Let me begin with some key points. Generally, in non-gaming sectors, we start by introducing ourselves and explaining our work. This often piques the interest of technologists who are already familiar with Unity, as many of them create games in their spare time. They begin experimenting with the project, which prompts us to offer professional services support since they may struggle to scale it for meaningful applications. As a result, they begin to increase their usage of our services. This was the model we discussed two years ago when we were a private company, and it does take time to develop. I had previously mentioned that there could be a gap of disappointment during this process. However, it’s a promising concept; it simply requires time to navigate. Forma and Reflect are streamlined applications that simplify the user experience, allowing access to real-time 3D without overwhelming complexity. This leads to increased demand for more usage, as you need additional resources to leverage the applications and services effectively. I anticipate that we will see significant growth in various sectors due to real-time applications that make it easier to adopt our platform. Occasionally, projects we collaborate on may evolve into real-time applications that we can offer to developers. For instance, Forma began with discussions in the auto manufacturing sector about creating car configurators, and this approach can be adapted for various products, like tractors, boats, or even custom jeans. The key takeaway is that we have recognized a pattern in these requests. By streamlining the process and removing obstacles, I have gained confidence in our potential for swift growth in non-gaming verticals.

Last but not least, Mario Lu at Barclays.

So I guess I'll ask the boring ones on guidance. In terms of the 1Q guide, if we assume a sequential growth for the Create segment in 1Q, I believe that implies mid- to high single-digit growth sequentially for the Operate segment versus, historically, it was growing around 20%. So if we're only assuming like a $2 million to $3 million hit from IDFA in 1Q, are there any other factors to call out regarding this lower sequential growth versus historical?

I'll provide a high-level overview, and Kim can add more details later. We're seeing our Create business accelerate following the transition out of COVID. While we're not releasing specific numbers, we anticipate that Create will grow at a faster rate than Operate in 2021. This expectation comes after a slowdown in the middle of the year, but now we see a promising pipeline for growth in various sectors, including gaming, driven by the new products we've announced. The challenges posed by IDFA primarily affect Operate, tipping the balance in favor of Create, which was primarily focused on Operate in 2020.

I think that's it. I don't have anything to add.

Okay. Great. So just one more on the full year guidance. The operating income margin guide at the midpoint is negative 10% compared to this year's negative 7%. Kim, you mentioned that headcount is particularly strong early in the year. Is it evenly distributed across sales and marketing, product development, and general and administrative? How should we approach that? What are your updated thoughts on long-term operating income margins for the company?

Yes. I may have mentioned earlier that we have a profitability goal for 2023 and we will continue to work towards that. Last year, the savings from COVID significantly improved our operating margins. This year, we are carefully balancing investments with the goal of maintaining profitability. We are prioritizing investments in R&D first, followed by sales and marketing. We are also focused on improving efficiency in our G&A expenses as we grow. In the first quarter, we are seeing strong growth in headcount, although we expect that to level off throughout the year. We are dedicated to maintaining our gross margins to support these investments while aiming for profitability in 2023.

Great. All right. Well, I've done it. 6:02 Eastern Time, so it was 8 minutes shorter than last time. So tried to help you guys out. Thank you very much for everyone, and we really appreciate all your great questions and insight and support. So we'll talk to you soon and hopefully, again, during the quarter and the next quarter. Thank you so much.

Thank you.