Unity Software Inc. Q1 FY2022 Earnings Call

…future financial performance and related aspects, which are all influenced by risks, uncertainties, and assumptions. You can find additional information regarding these risks and uncertainties in the Risk Factors section of our filings at sec.gov. Actual results could vary. We do not have any obligation to revise or update forward-looking statements. We will also cover our non-GAAP financial measures today, and reconciliations between our GAAP and non-GAAP financial results, along with discussions of the limitations of non-GAAP financial measures, are available on the Investor Relations website. Now, I will hand it over to John.

So good afternoon, everyone. Thanks, Richard, and I'm going to start launching into our script today. Before discussing earnings, I want to express our sincere thoughts for the people of Ukraine and hope that there's a peaceful resolution to the conflict as soon as possible. Our report today is a tale of two cities; first, we experienced challenges in monetization that negatively affected revenue in February and March and more persists through the third quarter with minimal impact on the fourth. Second, we continue to perform very well in Create with our gaming customers and with our non-game digital twins business where we saw meaningful growth, a trend we expect to continue. For the total company, revenue of $320 million was up 36% from a year earlier and came in at the top end of our guidance range. Upside to the forecast in Create was offset by challenges in Operate's monetization business. Non-GAAP operating margin of minus 7.2% improved 280 basis points from the first quarter of last year as we continued to invest in innovation to capture the large opportunity in front of us, while improving non-GAAP operating margins. I'd like to address our Operate business first. Operate started the year strong in January, but then significantly slowed down in February and March. This resulted in first quarter revenue of $184 million, an increase of 26% year-on-year. While there are external factors to consider, the Operate challenge is mostly caused by internal factors in Unity monetization in an otherwise healthy market. We see these challenges as temporary and not structural and do not expect them to impact future prospects of our business beyond 2022. The most succinct framing for the challenges we are facing is that we built more for growth and less for resiliency. Following years of rapid growth and working through the challenges of Apple's privacy changes, we got hit hard by two issues. The first was a fault in our platform that resulted in reduced accuracy for our Audience Pinpointer tool, a revenue-expensive issue given that our Pinpointer tool experienced significant growth post the IDFA changes. The second is that we lost the value of a portion of our data, training data, due in part to us ingesting bad data from a large customer. We estimate the impact to our business of approximately $110 million in 2022 with no carryover impact to 2023. Luis will provide a more granular update to our guidance in a few minutes. Here I will provide a deeper explanation of the specific revenue impacts. First, we have a direct near-term impact resulting from the two issues I just mentioned affecting the first and second quarters. Second, we expect a recovery to go through steps and sequence, data rebuilding, model training and improvement, and then revenue recovery as our customers scale up further on Unity monetization. And third, as a consequence of reprioritizing work in our teams to thoroughly address the resiliency and data training issues, we delayed the launch of certain revenue-driving features such as mediation, header bidding and new releases for Audience Pinpointer versus our original plan. We understand the problems and we are well advanced in addressing them. We are deploying monitoring, alerting and recovery systems and processes to promptly mitigate future complex data issues. We are strengthening and innovating our Audience Pinpointer product and we are already scaling Unity Mediation. Once done, we should be ahead of where we were at our very best. We have the right strategy to address today's challenges, and we have the right talent that has overcome many challenges in the past and come out ahead. We are on it. None of this takes away from our fundamental competitive advantage with Unity Monetization. The advantage is based on the fact that a strong majority of games are built with the Unity engine and analytics. We have proprietary data and insights coming from our reach to over three billion monthly active users feeding our contextual models. We have deep context about gameplay, what players like to play, when and how they play games. In gaming, this data has proven to be the most relevant for advertising. We have strong conviction of long-term strength and growth of the in-game advertising business. First, the games industry is the largest and most engaged audience of any form of media today with more than four billion monthly active users that we expect will continue to grow in scale and engagement. Second, less than 3% of players pay for their games. So an ad-supported model that is based on performance outcomes will always be a major part of the business model for game developers and there remains substantial opportunity for increased ad exposure in gaming. As a comparison, TV has approximately eight minutes of ads per hour of prime time. In comparison, we estimate that gamers see an average of four minutes of ads per hour of gameplay. Third, and as we've proven for years, in-game advertising works. Based on this understanding of the gaming ad sector, and on Unity's durable competitive advantage, we believe that Unity Monetization is an attractive growing and durable business for the long term. To close the Operate discussion, we’re very excited about Unity's Gaming Services or UGS going into general availability by July. UGS is our self-serve cloud platform that enables developers to operate and optimize their games and includes our multiplay business. Since its beta launch in October, we've seen more than 74,000 organization sign-ups with over 68,000 completed, which is more than a 90% conversion rate. And we already see that 30% of those new users are leveraging multiple products within the system. We are encouraged by these early adoption signals and feedback from our customers. Moving on to Create. We are very pleased with the momentum of our Create business, not just this quarter, but the momentum we are building with our customers. Create delivered a very strong first quarter, with $116 million in revenue, an increase of 65% from last year's first quarter. Our progress in Create is deep and broad as more creators and more industries adopt real-time 3D. In March, we shipped Unity's 2021 long-term support version of our Editor. This version delivers powerful improvements to creator workflows; a great example is our integration of visual scripting that enables creators to make content without having to write a single line of code. We added new rendering capabilities across all devices through our universal rendering pipeline and we enabled higher fidelity graphics across devices with our high-definition render pipeline. We shipped numerous improvements to developer workflows focusing on performance and iteration time, reducing the time to create. We have added new features to our world-building tools and enhanced artist-friendly tools like our powerful VFX Graph, Shader Graph, and Cinemachine tools. We expanded our already world-leading platform support, adding in Google ChromeOS as a platform and we added Apple Silicon support for the Editor. We are focused on constantly improving our tools for real-time 3D creators of all types. In fact, just today we shipped the latest release of the 2022 Tech Stream enabling game customers that are early in their production life cycle, with more tools for editor extensibility, productivity, platform optimizations, rendering capabilities, performance insights, and other key new features. Unity is the leading tool in service for game creators of any size to deliver their ambitions. The flexibility in multi-platform capabilities we provide is often a critical unlock for our customers in allowing them to deliver against their own vision. Let's start with our game customers. Here's a few interesting examples. Zenith: The Last City by Ramen VR has been a runaway hit on virtual reality. This title is a multi-platform massively multiplayer online role-playing game for virtual reality where players explore an anime-inspired world on Meta Quest, Meta Rift, PlayStation VR, and standalone VR devices. Ramen VR relied on Unity for our VR capabilities as well as our advanced data-oriented technology stack, or DOTS. Based on their success, they are now growing their team to bring the game to even more platforms including PC and web. This is something we see frequently with our Unity game customers, where our facility with multi-platform capabilities enables creators to find success and rapidly expand to more users and devices. Another exciting title on DOTS and shipping this quarter is Syberia: The World Before. The fourth edition of the Syberia series that launched to critical acclaim for PC, PlayStation, and Xbox and soon on Nintendo Switch. This title boasts huge and varied environments and more than six hours of stunning cinematics, made possible utilizing our high-definition render pipeline. Many large publishers use entities to create and sustain mobile versions of their games. This quarter, two great examples of this: Angry Birds brought back Angry Birds Classic to mobile app stores using Unity to relaunch this treasured game and easily make it work across multiple modern devices. And Ubisoft used Unity to deliver incredible visuals and fast gameplay in Rainbow Six Mobile. One final example back to virtual reality, StatusPRO unveiled the first true NFL football game for VR with NFL Pro Era enabled by Unity. These are just a few examples of the thousands of Unity games that launched on console, PC, web, XR and Mobile this quarter. Moving on to our work with artists. We are focused on delivering the most important tools for creating in 3D whether in media and entertainment, games or digital twins. In January, we officially transitioned the incredible team from Weta Digital to Unity. And since then we have been making significant progress in three specific areas: first, we continue to push beyond the edge of what is possible to deliver in visualization and simulation. We bought Weta Digital not just for a great set of tools that have been developed over the last 20 years, but specifically for their incredible experts and what they would do next. As you may have seen with a trailer for Avatar 3 released on May 6, these tools continue to set the standard for the art of the possible. Second, we are focused on building the framework for interoperability required to deliver these tools for more artists and for more use cases. In support of this, the team has been developing an end-to-end USD-based workflow, the first of its kind, replacing Katana-based workflows, while we've also been evolving the USD spec to support performant procedural data primitives, as well as physical camera and light standardization. In addition, we have been working to deliver a cloud-based render solution for the pipeline delivering millions of hours of render time to Weta FX per week. This is foundational work in building critical capabilities for artists and new revenue streams for Unity. Finally, we are focused on the work to bring these tools to real-time. We will be talking about some of these steps in this area at SIGGRAPH in August. Beyond Weta Digital, our art tools like Ziva and SpeedTree continue to make rapid progress. In Q1, we shipped SpeedTree 9 and Ziva VFX 2.0, delivering more capabilities in both games and media and entertainment. We see significant traction with these tools in games like Halo: Infinite and movies like Dune. Users of our Ziva Dynamics technology have won six Academy Awards including the Oscar for Best Visual Effects. Keep an eye out for those sandworms. One more note on Ziva. In the first quarter, we received more than 8,000 sign-ups in a multitude of cloud uploads for our beta of Ziva Faces. This service enables artists to use advanced machine learning models and massive data to train meshes for full expressiveness instead of requiring teams of artists to spend weeks doing manual rigging. This is an extraordinary and expeditious result that speaks to our goal to make 3D art in media, games, and everywhere 10 times easier, 10 times faster, and 10 times cheaper than it is today. We have more work to do, but we're gratified to see all this early traction. Moving on to Digital Twins. Our business continues to expand. We entered 2022 with nearly 3,000 customers in this space. Our digital twin customers are spending more time with us as we land and expand to drive tangible outcomes with real-time 3D across the enterprise. This quarter, we closed 34 deals above $100,000, up 126% year-over-year and up 13% quarter-over-quarter. Unity is being used in construction, commerce, manufacturing, advanced simulation and much more. We are seeing broad-based adoption of these tools from companies like Mercedes-Benz. Unity is partnering with Mercedes to power the infotainment domain of a new operating system called MB.OS. MB.OS is a fully comprehensive architecture covering electric and electronic hardware, as well as software, which will hit the road in 2024. It can be seen in the VISION EQXX prototype vehicle. As part of our partnership, we're also upgrading the Hey Mercedes personal assistant's intelligence and interactivity into a 3D Star Avatar that will be more akin to a digital butler. Additionally, the MB.OS system will allow for 3D navigation that can zoom from satellite view down to 10 meters. It will also account for what time of day it is, ensuring an accurate real-time 3D display. Also, in March, we announced how Zutari is changing the way that large-scale solar projects in South Africa are designed, created, and operated. Zutari is using Unity's real-time 3D development platform to automate large-scale solar photovoltaic projects to reduce the time required to develop design-level insights and decrease costs. Not only does Zutari complete sun tracking and shading for each solar panel, but they also optimize solar sites to enhance the number and position of the panels installed in order to increase energy output, all within Unity. Zutari is also using Unity to explore additional sustainable energy facilities. During Q1, we also achieved customer wins with our Digital Twins solutions across several new categories. From one of the largest energy companies in the world that is deploying our Digital Twins products across the enterprise to run their own downstream operations more effectively, to an iconic luxury brand that is leveraging Unity to bring to market a differentiated digital experience that can only be done in real-time 3D. Lockheed Martin is a model example of land and expand in action. Our first project with them started in 2017 when they bought a few seats for design visualization. Within 12 months, they had deployed 132 licenses to develop more interactive experiences for product development. Five years later, Lockheed has nearly 500 licenses across nine business units for multiple use cases including simulation, training, guidance, and collaboration. We are also making a difference in enabling how creators work. Parsec and SyncSketch are becoming critical tools in the hybrid work world. Creators need effortless access to high-fidelity workspaces and the ability to collaborate regardless of their location. The average time spent on Parsec per team's customer is more than 27 hours per week. This is what hybrid work looks like. Creators shift back and forth between direct access to powerful machines and remote to virtual access all without skipping a beat. The fact that we see incredible numbers and growth in such high sustained usage is a signal of the future that creative work requires. As you can see, we are making good progress enabling creators across industries to adopt real-time 3D. I've never seen such a global surge in creative innovation in my career, and we are honored to be powering much of it. We're seeing this innovation in gaming, AR and VR, and in many non-game verticals across thousands of projects that are created and launched on Unity every day. I want to reiterate my expectation that Unity will sustain and sustainably grow revenue at or above 30% per year over the long term even as we gain scale. I say this in full recognition that we're presently experiencing a self-inflicted challenge with our Modernization business that we expect to correct, learn from, and build a more resilient platform for the future. As we expect to drive 30% revenue growth while achieving strong levels of profitability, the $110 million revenue impact on our revenues this year hurts. We've been deeply considering ways for us to realize our vision on less, more focused spending. We can. We can make Unity a stronger company with this tighter focus and with it a faster move to profitability than we previously promised. We remain hugely focused on the long-term and these adjustments will make us stronger and leaner as we lead to the future. Luis will provide more details on this shortly. And when I say focus on the long term, this is what I mean. Unity's Operate business lives in an exceptionally large market. We have a material data advantage in our monetization business, continue to gain share with UGS as well as our hosting capabilities and believe we are more focused on gaming than our competitors. These are real advantages. And Unity Create is now hitting an inflection point that we have long anticipated. We are not only growing our gaming footprint and take rate, we are seeing strong adoption from industries beyond gaming. The tech industry sees waves of innovation from personal community, to Internet, cloud, online retail. Today, we're in the foothills of another big wave. This time the way people interact with digital content. We call it interactive real-time 3D. Others call it spatial computing or more recently, the Metaverse. Whatever it's called, it is different, it is more engaging, and it is inevitable. We are beginning this journey with substantial market share leads. Over nearly two decades, we have built a strong product and engineering-oriented team and business model that has let us earn the industry's larger developer footprint by a very wide margin compared with others in the space. We are selling into large and growing markets. Our digital core market of gaming could double in five years to more than $300 billion as it touches most people on Earth. And our opportunity in the gaming space is not just to double, it's more like five to 10 times as we grow into the largest user group artist and build out more ratable consumption-based services to augment our SaaS subscription. Meanwhile, other industries are just catching on. We have exciting momentum in Digital Twins, which boiled down will basically be the real-time digital replica of most places, objects, and persons on the planet. And when I look at projects in our development pipeline, I see more opportunities with the potential to scale to multiple billions in revenue. Non-gaming verticals have now gone at Unity from theory to early traction to scaling. We have to execute to earn our future opportunity. The challenges we discussed today will be addressed and resolved. It is not an industry or sector issue. We are well underway towards recovery and building and adding resilience and redundancy. And since all of you on this call have to publish your models, the question becomes exactly when Operate will recover and what that trajectory will look like. It is always harder to forecast to change the trajectory than a continuation of one. Our guidance reflects our best estimate of that curve.

Thank you, John. Let me frame a few considerations to understand the first quarter financials and balance 2022 guidance. The challenges that John described for Unity's Operate business negatively impacted our first quarter results and are expected to negatively impact our business in the second and third quarters, with minimal impact to the fourth quarter. I would provide further details in a minute. In the first quarter of 2022, we delivered revenue of $320 million, up 36% year-over-year. Create performed strongly, with revenue of $116 million, up 65% from a year ago. Operate softened, with revenue of $184 million, up 26% year-over-year. Strategic partnerships and other delivered $26 million in revenue, up 11% from a year earlier. We delivered at the high end of our guidance range with Create's overperformance partly offset by softness in Operate. We continue to make progress in expanding our business and adding new customers to the Unity platform. At the end of the first quarter, we had 1,083 customers with trailing 12 months revenue above $100,000. This compares to 837 customers at the end of the first quarter of 2021, an increase of 29% year-over-year. In addition, we delivered another strong net expansion rate of 135% on a trailing 12-month basis, this compares to a net expansion rate of 140% a year earlier. Our performance was fairly balanced by region with year-on-year revenue growth of 30% from the Americas, 34% from EMEA, and 47% from Asia. Our non-GAAP gross margin was 76.2%, down 210 basis points year-over-year, mostly as a result of including the additional engineers supporting Weta FX in the cost of goods sold. Excluding this impact, the non-GAAP gross margin would have been down 70 basis points year-over-year, mainly due to mix. Non-GAAP operating expenses in the first quarter increased 29% as compared to the first quarter of 2021. This compares to 36% year-on-year revenue growth. Our sales and marketing expenses in the first quarter included the cost of the in-person game developer conference, which we did not have last year. Non-GAAP operating margin improved from minus 10% in last year's first quarter to minus 7.2% this quarter. Cash flow from operations was $101 million, which includes Weta FX's $200 million subscription payment covering four years of license. We had 348 million fully diluted shares at the end of the first quarter and 5,864 employees, up from 4,389 a year ago. Moving on to guidance. Our original revenue guidance for the full year of 36% year-on-year growth at the top end of the range considered fairly even growth in each of the four quarters. As John mentioned earlier, the challenges we're having now with monetization represent a substantial short-term headwind to our revenue growth. We quantified this headwind at $110 million with roughly 60% impacting the second quarter, 30% impacting the third quarter, and 10% the fourth quarter. The recovery substantially rephases our year from being fairly even quarterly year-over-year growth to a year that is both front-loaded and back-loaded. For the second quarter, we expect revenue of $290 million to $295 million, representing growth of 6% to 8% from last year's second quarter, which was our strongest quarter last year with 48% year-over-year growth. For the full year, we're lowering our guidance to $1,350 million to $1,425 million. This implies 22% to 28% year-on-year growth. We're widening our guidance range to reflect different speeds in the monetization recovery. As mentioned, our modeling assumes partial recovery in the third quarter and to be largely back to our prior trend line in the fourth quarter. With our revenue coming down for the year there is, of course, an impact on our operating margins. This is not new to us today. While we believe Unity has massive opportunity in our future, we also think we can realize our vision with less spending. We have looked hard and can reduce our spending by over $100 million versus our internal plan. We believe this will make us a stronger company short and long-term. These savings will not have much of an impact in our second quarter but will have a substantial impact on the second half of the year such that we believe we will achieve profitability in the fourth quarter of this year, which is sooner than previously communicated. We expect to be profitable for the full year 2023. As a result of the slowdown, we expect a non-GAAP operating loss in the second quarter between $62 million and $64 million. For the full year, we expect a non-GAAP operating loss between $60 million and $75 million. We continue to invest to capture the large opportunity in front of us as we lay the foundation for the next 15-plus years. Yet, we have adjusted the pace of our investment given the slower revenue ramp to protect our margins. We expect 350 million fully diluted shares by the end of the second quarter and 356 million fully diluted shares by the end of the year. With that, I will open the call for questions.

Great. Thanks very much. So we'll go around as before. We'll call on the different analysts. And if we have time we'll also do virtual hands up. So why don't we start with the first question Kash Rangan from Goldman Sachs. Do you have a question?

Sure. I’m not sure if you can see my video, but the audio is fine. Thank you for providing your insights on the issues this quarter. John, could you discuss the timeline of Apple's privacy changes from their implementation to now? What effect might that have had on the Pinpointer tool? Additionally, if this is the correct assumption, what remediation tools are you offering to counter that challenge? Looking ahead, as you consider the WWDC, if there were to be changes making private relay a default option, how would you be prepared to manage any potential effects? Thank you.

So Ingrid is on with us today, but I'm going to give you one quick headline. We're well aware of Apple's plans where we provided our original guidance. So the change in guidance is not based on a change understanding of what Apple is doing. But Ingrid's here. It's her business. I will let her address your questions more specifically. Ingrid?

Yeah. Hi. Kash. Just want to be clear that the issues that John outlined today are not as a result of iOS 14 impact; those are two different issues. And then, as for iOS 16 and the outcome there, we've seen several media stories that, speculate what you just mentioned for the privacy changes could be coming in iOS 16 and that privacy relay could remove the use of IP addresses. However, Apple has not announced any details. Today, we are actively working to make sure that our systems are ready for start and prepared for the different possible outcomes to address any changes in the privacy landscape.

Great. Thank you so much.

Great. We'll go to the next caller. Matt Cost at Morgan Stanley. Matt?

Great. Thanks for taking my questions. So when I look at sort of like the cadence of growth that's implied by the new guidance, assuming it kind of accelerates as we move through the year, it's something maybe like from $295 in 2Q, maybe adding $50 million and maybe $100 million in 3Q and 4Q to get to the high-end of the full year guide just round numbers. I guess, when we think about what precipitated the issues with Audience Pinpointer earlier in the year, what gives you confidence that that pressure will abate so quickly? And you'll be able to step-up kind of so rapidly over the course of the second half of the year? And then, I have a follow-up. Thank you.

Sure. So I'll take a high-level. Ingrid, you may want to add some value. It's up to you or for Luis. We spent a fairly substantial amount of time, as you might imagine, understanding exactly what happened. We've got deep insights into each of the component parts. And it gets divided over correcting problems that we're in the process of completing. So we're well through a fair amount of the work it takes to address the problems we've outlined. And then, one of the things to keep in mind as well is for the past years we've been meeting or exceeding our numbers. A major part of that is attributing revenue to new features and new performance enhancements. We've been very good at that. So the corrections are like the inverse of a performance enhancement. And we still have the feature map that we've always had. And so, it's really just drilling down and doing what we've always done for our forecasting. But this time around, if you will, it's almost like a feature to correct the problem because it has the same impact. The value of an install is more carefully and correctly understood. Reaching more users through our Pinpointer tool is another example. We know how that math works. Ingrid, anything you might want to add?

Yeah. Matt, this is the nature of machine learning-based products. We expect our recovery to go through several steps, in the sequence. The first is data rebuilding. The second is model training. And this is an iterative process that will drive better performance. The third is then as our customers experience these improvements, they will scale up their spend and monetization with us; we will then see the impact on our revenue. So these changes are incrementally built upon one another as each step in this progression is the foundation for the next. And, look, we're building this business for the long term because we truly believe in this sector. The games advertising market, as John mentioned, will continue to grow. We have highly engaged players and professionally created content. This will always be attractive for advertising. And we know what we need to do to address this temporary challenge and we need to go through the motion to ensure the solid foundation. Lastly, what I would mention is that the beauty of this business is that no customers have a loss and the sales cycle is short. For many of these developers, Unity has enabled them to achieve their vision and build the business that they have today. We have built a trusted brand and a reputation over the years such that when we deliver value we are confident that they will scale up their business with us again.

Great. Thank you. And then just, on Operate, I think in the prepared remarks you mentioned basically an idiosyncratic issue in 1Q in a market that is otherwise healthier or stable, I forgot the exact wording. But, I guess, when we think about your expectations for the growth of like the mobile game advertising market through the end of the year, are you assuming relative stability through the end of the year, or is the market backdrop that you're imagining in your guidance including any impact of some macro weakness potentially?

So it's always difficult to be exactly precise on what happens in the macro world is, arguably more going on in the macro world today than there has been in a long time. I don't see any long-term impacts on engagement and the overall health of the monetization business with large or with small onto Unity as we recover. So we're expecting relative stability. And let me give you a little bit of my long history in the game industry. Through virtually every major crisis, the game industry has grown. Through recession, the game industry has grown. Through catastrophes like 9/11, the game industry had strong weeks immediately following. It is what people do when they're frustrated. It's what they do when they stay home because they can't travel. It's what they do to fill their time when they're stuck at home with COVID, and it’s the habit they pick up and they carry with them. Can there be uneven quarters from time to time? They can, but they're exceptionally rare in the gaming industry. And it really is the habit that people pick up and maintain once they start. And it's one of those few things where, when people come under more pressure and more stress, they tend to gain more. So, again, I'm highly confident that this industry is strong. Can things get knocked back and forth in the quarter? Of course, they can. But the trend lines of the industry that we look back more than decades now has been pretty consistent up to the right, no major retrenches. Now, in years past, when we had primarily physical media in the gaming industry, you saw some cycles where the console business would go backwards in the year leading to console launches because customers would wait to get their new console and buy more discs. That phenomenon is trivial now. What happens today is increased growth based on new users being more engaged over time.

Great. Thank you.

Thanks so much. Brent Bracelin at Piper.

Good afternoon. I wanted to go back to the Monetization challenges you're seeing. I guess I'm a little surprised to think about one customer and data from one customer having kind of this big of a challenge. So maybe just stepping back how dependent is the Operate business on data from your other customers, or is this data from a third party that you're getting to help drive the service? Just a little more color on kind of how data from one customer could have this big of an impact on the business here just this quarter?

So Ingrid, do you want to take that? I can add.

Sure. Brent, I just want to make sure that we are clear. It is not the whole impact because of this one data from the customer.

Okay.

There were several factors that were outlined. The first was a fault in our platform that resulted in reduced accuracy for our Audience Pinpointer tool. As we grew significantly last year in Audience Pinpointer, as John mentioned, we paid more attention for growth and new features versus resiliency. So this was an expensive issue given that Pinpointer is a big component of our business post Apple's privacy changes. The second...

Just to be clear though is that Pinpointer product data dependent, or is it actually like a software bug issue that caused the problem? I'm just trying to dissect is it a data challenge, or is it actually a software bug issue?

The first factor I mentioned is a combination of various elements that decreased the accuracy of our Audience Pinpointer. The second factor involves several incidents that affected our data set, which is used for training our machine learning model for Audience Pinpointer. One specific example of this is that we received a large amount of data from a customer.

It felt a little bit like it was one customer dataset. It sounds like there's several factors that had influence on the data training issue and then there was, obviously, something that also impacted the Pinpointer product. My last question maybe for Luis. As we think about the guidance for Q2, you talked about some of these challenges cropping up in February and March. It looks like the guidance implies about a $60 million drag to operate for Q2 that's $20 million a month. Why would it be such a bigger impact if you saw some of these initial impacts in February and March for Q2? It seems like it's a more material impact clearly for Q2 than what you saw in Q1, why is that?

Yeah. So it's just the timing. So in January we started very strong. As John mentioned the impact to February was relatively small, the impact to March was larger. So you see a partial impact in Q1.

Got it. So it's not like the issues are worse. It's like you're addressing most of the issues in this.

Yes.

The next question from Dylan Becker over at William Blair.

Yeah, hey guys. First maybe I wanted to touch on the value of the Create platform so an area that obviously saw a lot of strength and continues to see strength here. But as you guys are thinking about kind of the confidence in this ramp throughout the middle quarters of the year and into the back half how much of that activity on the Create side and the insights and the data that you're able to draw from that tool gives you the confidence and support as we think about the ability to kind of retrench a lot of these models from a user targeting perspective? And then I have one more follow-up to that.

Marc, do you want to help with that a little bit or I can take it? Marc?

Sure, I'm happy to start. I think the question was a little bit about how the flywheel between Operate and Create. So what's been awesome, in particular in the games is that our Create tool set is used by an incredibly broad set of creators across pretty much every platform where users are found. And as those creators are going to market a huge number of them then onboard into the Operate tool chain. Now, because we start from the very beginning from the very first time that someone hits file new project inside of Unity we start sort of understanding where they're going, we're able to work with them at a team's level, and then move them over onto the Operate platform. The other part that we continue to strengthen together is the work that Operate has been doing and what they call Unity Game Services, where it's not just the monetization side but also the other areas around analytics, voice, and multiplayer, as well as cloud content and delivery that ties in very deeply into both the creation and in the long-term operation. And then Ingrid, I don't know, if you'd want to add anything on that on how that helps from your data perspective.

Yeah absolutely. So as we've seen, as John mentioned, since beta launch in October, we've seen more than 74,000 organizations sign up with over 68,000 completes, which is more than a 90% conversion rate. And all of that doing beta is coming from the Create platform and Made With Unity developers. So, to just give some data points to support Marc's narrative there, we are seeing the impact on this, particularly on Unity Gaming Services.

Can we get into your question exactly because I interpreted the question slightly different than we answered it. I want to make sure we're answering your question.

Yes. I mean I think from a high level right it's around how the Create side can service that on-ramp from the operation monetization dynamic. And as you guys are kind of trying to again figure out and dig into to better optimizing some of these models. I think that that helped address it from a high level and maybe a quick follow-up too. So seeing kind of the strength I know you mentioned on the Digital Twins side, but like the interoperability of visualization here too as we think about seeing kind of traction and expansion into some of these non-gaming use cases, how should we think about maybe areas that are seeing the most momentum? And then maybe the opportunity to drive Operate strength outside of kind of the core non-gaming component today? Because I think a lot of the momentum you see is solely and creates the ability to kind of leverage the Operate side of the non-gaming component as well. Thank you.

Sure. Why don't I start with that one and then John, I don't know if you have something to add. But I think it's a really great question. Digital Twins I think we're seeing really broad growth across multiple sectors as we see industries using these Digital Twins to manage their business at every phase. We see them using it at content creation and injection time to product configuration and sales collaboration, and then really deeply around management operations and simulation. And you can look at that across whichever industry that you want to look at; they tend to be focused across those different phases. Today we've been, and we continue to be strong in areas like architecture, engineering, construction, manufacturing, automotive, but we're also seeing a lot of significant growth in areas such as high end and luxury retail and also in complex products. I think everything from elevators to boats and sort of being able to build systems that support both the on-ramp of new customers through the operation of those products. What's been very encouraging is that where we see our customers is they begin – they are beginning to staff dedicated engineering teams in these areas not just asking for professional services. And so what we see is that they see Digital Twins not as a point engagement, a one-time thing but as a continuing capability. And that really speaks to how you think about not just the creation of an original digital twin but its use over a lifetime to operate capabilities and the opportunity to create services and value add on that long term.

Let me expand on this point. Our company originated in the gaming industry, and we are fully committed to supporting game developers, which is evident from our rapid growth. Over the past few years, we have become a market leader on all gaming consoles, transitioned from minimal presence to leading in the PC sector, and grown our mobile market share from the low double digits to over 70%. Our energy is focused on these areas. Additionally, we are developing services that increase our take rate, and that progress is continuous. About five years ago, I hired someone just a few blocks away, marking the beginning of our efforts to branch out from gaming. Back then, I faced skepticism about our ambitions. However, fast forward to our public offering less than two years ago, we discussed our customer base, which was still in its early stages. In the last six months, I’ve witnessed unprecedented growth. I meet weekly with CEOs and Board Directors across various industries including automotive, architecture, construction, and retail, showcasing a diverse range of companies. This situation reminds me of the year 2000, when we believed that maybe 5% to 10% of companies would eventually have websites. Today, virtually every company has an online presence as it's essential to business. Similarly, I'm observing significant interest around the concept of the metaverse, representing the next evolution of the Internet. This allows businesses to implement features like virtual try-ons, bringing stores into customers’ homes, and facilitating real-time 3D connections for a variety of products. When we discussed this at our IPO, it was intriguing, but the landscape has shifted dramatically. Companies are not just becoming interested; they are deeply investing in these capabilities, fully acknowledging their necessity as it evolves rapidly.

Great. Thanks guys.

Thanks. Appreciate it. Next question Andrew Uerkwitz at Jefferies. Andrew? There we go. Okay, Andrew, we'll circle back to you. Stephen Ju over at Credit Suisse, do you have a question?

Yes sir. So I just wanted to circle back on Pinpointer. So it looks like a product that helps app developers reengage users who have already installed the app. So can you confirm that this is indeed the case? And if so can you talk about what kind of campaigns were impacted in terms of different buckets of what advertisers are looking to achieve? And also secondarily, was this a problem that was presented to you by your advertisers who were starting to report compressing ROIs and therefore starting to rotate budgets away from you? I'm just trying to figure out like how this problem was identified in the first place. So in terms of the practicalities of getting the budgets back on board, is this a matter of just training your models to ramp ROIs back to where it was in the first place? Thanks.

Yes, Ingrid.

Audience Pinpointer is our user acquisition product powered by machine learning, enabling game developers to acquire players based on a target return on their spending. Advertisers have various purchasing options, including a target return on app spending and a target price per install, alongside other factors like retention. To clarify, this is not retargeting; it's focused on user acquisition based on return on ad spend. The problem was identified through a combination of analyzing our customers' data and our own data, with our engineering team investigating root causes and pinpointing the issues.

Okay. So presumably on a go-forward basis, would you have access to less data that would be informing, I guess, the models? And would you anticipate that the ROI is using Pinpointer would be better or worse versus where you were before?

Yes. As I mentioned, the recovery will go through several steps. The first is data rebuilding. The second is model training, and this is an iterative process. And as we train the model more the performance will improve. And the third is then as the customer experiences these improvements, they will increase their spend and monetization with us, and that's when we will see the impact on our revenue.

And just for clarity we didn't lose any customers. One of the early signals we saw was that we saw less revenue. And so they're spending less because they're getting less performance out of Audience Pinpointer. Ingrid's team took that apart, and I saw a multi-variant analysis showing each individual component part and that was driven in part by some of the data issues we talked about. So the diagnosis is crisp. Those same advertisers, when they start to see the performance that we know we can drive as new data fills in and we train those models, it's a straightforward process of bringing them back up into their share of wallet. These people are really data-driven. For those of you that work in other industries primarily or have worked in other industries, there's almost nothing like the data-driven nature of a user acquiring marketing team in the game industry. These guys move on tenths of a point in one point. And we know what we can do in performance, which is why we're able to confidently give some good sense of how this will come back. We saw how it went. We know how it comes back.

This doesn't take away from the breadth of data sets that we have to inform our contextual data. It's just we have some challenges and issues as a result of these temporary technology issues and reduction in data. But in terms of the fundamentals of kind of the breadth of data that feeds into our condition this doesn't take away from that.

I can't say this with absolute certainty, but in an industry like ours, the data we accumulate over the past 90 to 180 days constitutes a significant portion of its value. This data is recent, and once we resolved the issue, it became somewhat self-correcting. We are now more proactive in addressing corrections, but it is easy to misinterpret the situation. The revenue challenges we experienced were linked to the misses we previously mentioned, which directly impacted us, the time required to rebuild, and the rephasing of features. We are quite confident in those rebuilding efforts.

Thank you.

Great. And our last question Parker Lane with Stifel. Are you available?

Yes, sorry –

I wanted to talk about the opportunity outside of gaming. You touched on it briefly a couple of questions ago. But I'm just thinking about the way that these organizations across a variety of industries think about their investments and innovation in real-time 3D. Is there anything uniform about that, or is everyone really taking at a different pace? Like, when we think about the customer expansion opportunity there, is it perhaps many factors larger than what you would see with traditional gaming customers on the Create side? So there's a lot of pattern recognition you can talk about here, and I'm going to ask Marc to build on this. But I'm going to give you one part of it, almost an organizational level one, and I'm going to ask Marc to talk about some pattern recognition around whether it's simulation centered or it's configurators, or it's reaching their customers with a new presentation. One of the things that I've seen is if I go back to five years ago, and I mentioned this before I talked to my first person into working on this business three years ago, I’d show up with a customer and we'd get handed off to a relatively junior person in the organization and three engineers, one of whom has a kid that programs in Unity; they're just curious to meet us. And we'd show up and we'd say, 'How do you do this? And how do you do that?' Whether it's design, or how to do your car configurator. I was shocked at how archaic some of that was. And there was nobody very senior in these organizations that we were interacting with. That started to change about three years ago. We were getting into important people in the marketing or design, or different parts of the processes of those organizations. Today, what's happening, it's CEOs accompanied by their Boards of Directors and their entire senior management team say, 'I know I've got 10 experiments with you at a low level, we want this to be transformative.' So one really significant point of pattern recognition is where this has evolved to and where they get resources from, which is why I'm very confident that we're in the scaling phase and we've moved well into that. I'd love to talk about a number of specifics, but I'll take the air from Marc and I'll let him expand on that.

Sure. Thanks, John. Yes, I think there are some really interesting patterns that are relatively common across industries. And then you can also see where there's a lot of growth to come. Many industries create at least in some level in 3D. They use CAD tools. They create their manufacturing, or their designs in some sort of 3D package. For many years, those were then sort of transformed through their own process, and then someone would come with a camera and take photos of the final product. And if you wanted to show a different configuration, they would take photos of another product that was configured differently. Because the data from that sort of core engineering component didn't easily flow to where customers were or where the use case need was over the long term. So what we see is there's a very common pattern where these companies want to ingest the huge amounts of data that they have in 3D, which by the way can in many cases be much larger than the content even in large games, in terms of polygons, in terms of meshes or point cloud data when they're looking at sort of what they have. They want to take that. They want to be able to easily configure it not just at an engineering level but at an end customer or product marketer level. They want to be able to manage it across multiple streams. Take automotive as an example. Many of the use cases that automotive has for the HMI systems inside of the car, they also want to work effortlessly on a customer's phone. And so, the 3D capability to be able to transform from kind of static creation at the front end of a process through every phase of creation, whether it's simulation, management, configuration, all the way to the end user following the exact same pattern that we've seen in games, which is customers want access to things across the screens that matter for them, whether that's a PC, a laptop, or a mobile phone or MDR. And so when we look at what we can do to deliver on a bunch of solutions inside of Digital Twins, it's about enabling that easy flow of data and use cases across the life cycle.

And then just one more layer on patterns. One part of this is customers wanting to reach their customers and sell better. Configurators, 3D showrooms, virtual try-ons; they're trying to communicate better and more richly, increase basket sizes, and increase transactions. Other thing people are asking, of course, they want to operate something. They have a manufacturing facility. They want to run it in the Digital Twin. They want to run massive simulation in parallel with that to get 5%, 10%, or 1% improvement in efficiency and effectiveness. They want to run and test new configurations. And so it's an operating IoT-driven thing. And then another arena for this is design. And by way of example, it's relatively easy to use Unity to put a car on a bridge and do what you could do in a wind tunnel, infinitely cheaper and infinitely better to run simulation around that and help inform their design. Another fourth area is people are using it for training. So a lot of training around this. So operating something from an airport to a manufacturing facility, reaching a customer for retail, and helping them buy; these are all patterns. And so, we're getting closer and closer to being able to say the professional service component can shrink away over time. We'll still be doing a lot of professional services. But these are increasingly products we can put in front of customers they can just use to do a lot of these things. But that's where most of the energy is going for the stuff.

Got it. I appreciate all the commentary. Thanks again.

All right. Well, thank you very much everyone. We'll be at conferences in June at Bank of America, William Blair, Stifel and Wedbush, and we may see you at those conferences. So until then have a good rest of your day. Thanks so much.

Thank you all.

Thank you.