Earnings Call Transcript - U Q3 2020

Operator, Operator

Thank you, and welcome everyone, to Unity's First Financial Results Webcast, highlighting our Results for the Third Quarter of 2020. It's great to have you join us today after a successful initial public offering. With me on the call today are John Riccitiello, President, Chief Executive Officer, and Executive Chairman; and Kim Jabal, Senior Vice President and Chief Financial Officer. After their remarks, we will open the call to a question-and-answer session. I'd like to remind all participants that during this conference call, any forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including business outlook, expectations for future financial performance, and similar items, including, without limitation, expressions using the terminology, may, will, and believe, and expressions that reflect something other than historical fact are intended to identify forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including those discussed in the Risk Factors section of our filing with the SEC. Actual results may differ materially from forward-looking statements. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events that may arise after this conference call, except as required by law. For more information, please refer to the cautionary statement included in the slides we have posted to our Investor Relations website at investors.unity.com. In addition, during the meeting, we will discuss non-GAAP financial measures. These non-GAAP financial measures are in addition to, and not substitute for, or superior to measures of financial performance prepared in accordance with GAAP. The reconciliation between GAAP and non-GAAP financial measures and a discussion of the limitations of using non-GAAP measures can be found in today's earnings release, which is available on our website and as an exhibit to our filings furnished to the SEC. With that, thank you for joining us, and I will turn it over to John.

John Riccitiello, CEO

Thank you, Richard. Hello, and good afternoon. Thank you for joining us today for our first public company earnings call. I hope you and your loved ones are safe and in good health during these difficult and turbulent times. I want to begin by thanking the amazing team that got us to this point from our founders 14 years ago to our employees around the world, our advisers, and our new investors. We would not be here today without our customers, the creators, the developers, the artists, and the dreamers. We're looking forward to sharing details about Unity and our third quarter results with you today. As many of you are aware, we capped our third quarter with a successful IPO that we conducted virtually. The IPO, or as we like to call it, the UPO, was the second largest software IPO in the last decade and was executed under an innovative structure which gave us better visibility and demand for optimal pricing and allocation. It also gave our employees the opportunity to sell a portion of their shares and vested options on day one of trading. We welcome all of our new shareholders here today. Kim Jabal, our Chief Financial Officer, will detail financials in a few minutes. But before we dive in, I want to highlight three key points on our Q3 performance. First, despite several macro crosscurrents, we grew revenue 53% compared to Q3 of last year, and we generated a 79% non-GAAP gross margin. And our non-GAAP loss from operations was $8 million versus $28 million last year. Second, the metrics that drove those numbers were good as well. One of the KPIs we focus on is the dollar-based net expansion rate. And for the third quarter, that ratio hit 144%, thanks to a combination of strong execution and some tailwinds from COVID-induced work-from-home policies. And third, you can't deliver good financials without a strong foundation of innovative products and services as well as a tuned go-to-market strategy. Here are some interesting statistics. In the first nine months of 2020, we've seen an average of more than 5 billion downloads per month of applications built on Unity. And as of the end of Q3, we had approximately 2.5 billion monthly active end users who consumed content created or operated with our solutions. Ninety-four of the top 100 game development companies by global revenue are Unity customers. And as of the end of Q3, ten of the top ten auto manufacturers are using Unity. Unity is the world's leading platform for creating and operating interactive real-time 3D content. Creators and developers use Unity to build, to run, and monetize interactive real-time 2D and 3D content for more than 20 different platforms, including mobile phones, tablets, PCs, consoles, and augmented and virtual reality devices. Much of the content consumed today, like TV and movies, websites, social media, YouTube, and TikTok, is static or non-interactive and/or 2D digital content. Real-time 3D interactive content allows end users to connect with the content and with each other. Media built on Unity's real-time 3D platform gives users agency over their content, allowing them to control what they experience next, rather than being passive consumers of content. This interactivity, together with a full 3D perspective, allows for a fundamentally more engaging and immersive experience than traditional content does. We believe that most of the world's content will, in time, be real-time 3D, and it is our intent to be the driver toward this future. Now it was a bold idea some years ago that a third-party engine like Unity could grow and ultimately be the technology under most of the world's games. And it is a bold idea today that industry after industry will convert from their 20th-century dependence on non-interactive, low-engagement 2D tools to embrace real-time 3D. Technologically, we build a single platform that enables our customers to build, to operate, and monetize applications. With Unity, you build an application once, and that application just works seamlessly on more than 20 platforms. Instead of mastering and porting their content to additional platforms, developers can focus on creating great content and on multiple paths to success. And while there are blockbuster AAA games that cost $60 or more upfront, today, far more games are initially free-to-play, and that's great for consumers. But game developers need some revenue to pay the bills. And they do this through in-game advertising and in-app purchases that make the game more engaging and enjoyable. And that's where Operate services from Unity come into the picture. Five years ago, we launched our monetization products. Unlike traditional ad works that optimize exclusively for eCPMs, we designed our platform to help our customers maximize engagement, enjoyment, and the lifetime value or LTV of their users by leveraging unique data and proprietary AI tools. This might sound like a relatively easy task, but it was not. We started with a few hundred thousand player behavior data points. But with a lot of work, we gradually built one of the leading data networks for gaming. We've reached the scale where we ingest 60 billion in-app events per day. This data helps us deliver better LTV and lower costs to acquire for our customers. And this has helped us build one of the largest monetization platforms focused on the games market. We also offer additional Operate solutions, including deltaDNA and user engagement, Multiplay, cloud hosting and orchestration, and in-game communications through Vivox. Today, these technologies mostly apply to gaming, but we see many opportunities to extend our platform into other industry verticals in the future. We are a market share leader and have strong healthy growth opportunities across the board, both in Create and our Operate businesses. We're not resting on our laurels. We have big ambitions. First, we continue to focus on our core gaming market and believe we can increase our business in this sector significantly in the coming years by continuing to innovate and leverage our data advantage and adding new Create and Operate tools and services. Beyond gaming, we began to focus on new verticals just a few years ago. We're growing into new verticals like industrial, automotive, architecture, engineering, and entertainment, rapidly solving more and more customer problems and identifying more and more use cases. And while we're gaining rapidly in these sectors, we are also examining new industries to enter and expand. Let me give you a few examples. Toyota worked with Unity to create a mixed reality system for diagnostics and repairs for their dealerships and service networks. This was a high-stakes decision because repairs have a significant impact on brand perception. Toyota used to manually tag 20,000 pictures to ingest them into a learning algorithm, a process that took about 200 hours. Toyota turned to Unity to build accurate 3D models of the body and engine compartment. This reduced Toyota's workflow time to 30 minutes, a 400 times reduction. Valerio Dewalt Train was invited to build on the design of a 36-story, 390-foot tall Bell Tower and Bell Park Office Building in Denver, Colorado. This was a complicated project because the location and the size of the tower mattered to city planners. Valerio deployed our architecture product, Unity Reflect, to geolocate the building on site and develop an augmented reality digital twin. By using Reflect, Valerio Dewalt Train built a prototype in less than four weeks and won the bid with the city. Now I want to wrap up with a discussion of what we hope to turn into a tradition on these earnings calls, a brief highlight of some of the new innovative products that our development teams have built. In September, we launched the LEGO Microgame, a free-to-use set of modules that allows entry-level users to build and share their first 3D game in less than an hour, using a simple no-code interface. In adding the LEGO Microgame to our growing portfolio of templates that help new users to start creating successfully, we believe the low-code, no-code market will become a substantial part of Unity's business in the years ahead. And we are grateful to work with such a well-regarded brand to help bridge the gap between physical products and the virtual world. And for Unity, we have built a low-friction on-ramp for budding new game designers. In Q4, we're launching another application specifically designed for verticals outside of gaming. It's called Forma. And it's an example of our ability to build technically advanced applications that are intuitive and easy to use. The shift to working from home has accelerated the move to virtual commerce. Meanwhile, today's shoppers are more sophisticated, and they expect to see their visions come to life in real-time. And this is where Forma comes in. One use case for Forma, as an example, is an automotive manufacturer that creates advertisements, product guides, and a car configurator that are engaging, interactive, and in real-time 3D. This gives customers a much richer visualization for their potential purchase, including colors, fabrics, and accessories. In that way, Forma gives marketers a tool to differentiate themselves from their competition. We've made great progress, but we are just getting started. At Unity, we believe the world is a better place with more creators in it. And we intend to realize this belief by making real-time interactive 3D the dominant form of content worldwide. As a company, we will invest for the long-term to ensure we deliver for our customers, the Unity developer. And through this long-term investment orientation, we aim to drive significant growth for many years to come. We welcome our new shareholders on this journey. Now let me turn over the discussion to Kim Jabal, our CFO, to go through our financial results.

Kim Jabal, CFO

Thank you, John, and thank you all for joining us on our first earnings call. This is an exciting time, and I want to echo John's thanks to the entire Unity team for their hard work and dedication that has led us to this moment. We are very pleased to have started our public company life with such a strong quarter. Let me begin by reviewing our financial results. Revenue for the third quarter of 2020 was $201 million compared with $131 million in the third quarter of 2019. This is an increase of 53% year-over-year. Our revenue mix has shifted in 2020 towards Operate Solutions, with Operate, Create, and Strategic partnerships accounting for 60%, 31%, and 9% of revenue, respectively, in Q3. One of our key metrics, the dollar-based net expansion rate, sustained its recent high levels, coming in at 144% compared to 132% as of September 30, 2019. Please note that some of our expansion in 2020 was driven by COVID tailwinds in the Operate business, and this may result in a tough comparison in 2021. Drilling down into our operating groups, Create revenue grew 45% to $63 million. While the first half of the year introduced some COVID-related headwinds as game developers adapted to work-from-home environments and deal cycles slowed, we saw recovery in Q3 in our Create business. Our customers are turning to Unity to help them create and build everything in real-time 3D, from the next generation of office buildings to self-driving cars to the video games enjoyed by millions of people around the world. Operate Solutions had a very strong quarter, growing 72% versus last year. These results reflect strong execution and product improvements, alongside higher end-user engagement with games built by our customers. This is driven in part by COVID tailwinds. Our Operate Solutions are aligned with the success of our customers. This is really important. When our customers grow their engagement with their end users, when they grow their revenues through the use of our monetization tools, they grow their usage of our services, and this drives our revenue growth. Strategic partnerships revenue was flat with last year at $18 million. This reflects slower deal cycles driven by COVID, as well as the sunsetting of certain products within our partners' portfolios. This revenue line remains very strategic for us, but it can be lumpy from quarter to quarter in terms of growth. Non-GAAP gross margin was 79%. This compares to 81% in the third quarter of last year and 78% in the second quarter of 2020. The year-over-year decline was due primarily to higher professional services driving growth in new verticals with the acquisition of Finger Food in April, as well as increased hosting costs to meet the demands and growth from our Operate Solutions business. Non-GAAP loss from operations for the third quarter was $8 million or negative 4% of revenue compared to a non-GAAP loss from operations of $28 million or negative 21% of revenue in the same period last year. A substantial part of the year-over-year improvement was driven by one-time savings that we recognized related to COVID, primarily related to travel, events, and facilities. Now turning to our guidance. So to set the context, I want to reiterate that 2020 has been a pretty unusual year with lots of uncertainty related to COVID. We aren't counting on our normal Q4 seasonal jump in our Operate Solutions business, as we believe the increase in user engagement that typically happens around the Q4 holidays has essentially already happened. In addition, additional uncertainty for our game development customers occurred with this year's announcement from Apple of new policies for the IDFA, which was originally slated for introduction in Q4 but is now delayed until sometime in 2021. From an expense perspective, we expect to reinvest some of the material COVID-driven OpEx savings that we achieved throughout the year into incremental marketing programs and hiring in R&D and sales in order to continue to drive our revenue growth. So for the fourth quarter, we expect revenue of $200 million to $204 million and a non-GAAP loss of operations of $35 million to $40 million or approximately 17% to 20% as a percent of revenue. Our revenue outlook for the full fiscal year ending December 31, 2020 is $752 million to $756 million. This is up from $542 million in 2019, reflecting year-over-year growth of 39% to 40%. We expect the non-GAAP loss from operations for all of 2020 to be $66 million to $71 million or approximately 9% as a percent of revenue, down from $92 million in 2019. We expect the weighted average fully diluted share count to be approximately 321 million for the fourth quarter. I'd like to point out that Q3 free cash flow of positive $11 million benefited from strong performance within our Operate Solutions business alongside an increase in net working capital. Although we're not guiding free cash flow, you should expect it to remain volatile quarter to quarter, and we expect to drop back into negative free cash flow in Q4. And that concludes my prepared remarks. So thank you, again, to the entire Unity team for the hard work that has led us to this point. And thank you to all of our new shareholders. We are honored that you have decided to join us on this journey. And with that, John and I are now happy to take your questions.

Operator, Operator

Great. Thank you, Kim. So we'll start today with Heather Bellini at Goldman Sachs.

John Riccitiello, CEO

I'll take a high level, and Kim may want to dig in a little bit. On a high level, Heather, our view was that vis-à-vis iOS 14 and the changes in IDFA, we were not anticipating material disruption in Unity's business. We did expect there to be, and we had imagined that there would be a relatively modest, very near-term disruption that would have occurred in Q4 as the demand side started to wrestle with exactly how effective each of the relative platforms was per user acquisition. We view ourselves as a monetization platform, less so an ad platform, and we believe we've got a fundamental advantage on the data side. And that advantage on the data side means that at least we feel we'll be materially less impacted by issues like IDFA. We analogized somewhat to what happened with GDPR, where the anticipation was the entire market would go into a bit of a flux and then there'd be a little bit of a reordering in market shares. And that's exactly what did happen, and in that, Unity was a net beneficiary. We're not guiding you to believe that we think we're sure it's going to be a net beneficiary situation. But no, we haven't seen anything material and don't anticipate something material for us. In terms of the gaming industry, there's no question there's an increase in usage. Now that affects some of our business, not all of it. It doesn't have a material effect on the Create side, for example. And in terms of seasonality, one of the things that Kim and I were talking about just yesterday is we would normally see a more aggressive increase, particularly on modernization, but also operate and hosting in Q4 as consumers and gamers would be home a lot during the Thanksgiving to Christmas holiday. They're already home; they can't go home twice. And so as much as we would normally anticipate a pickup in Q4, and that pickup would be directly attributable to more game time because of people being home and out of school, it's hard to see how we get that same lift in Q4. A consumer basically can't be home twice.

Heather Bellini, Analyst

Great, thank you so much.

Kim Jabal, CFO

I don't think so. I think you covered it. Thanks.

Operator, Operator

Okay. Great. We'll go to Brad Zelnick at Credit Suisse.

Brad Zelnick, Analyst

Great, thank you so much. Can you guys hear me?

Kim Jabal, CFO

Yes.

John Riccitiello, CEO

Yes.

Brad Zelnick, Analyst

Great. Awesome. Congrats on the first quarter out of the gate. John, you now have a big war chest post the successful IPO and no shortage of exciting growth opportunities ahead. Can you just help us understand how you approach investment priorities? What are the most impactful areas of investment as you think about your overall opportunity set? And maybe how has competition or the larger capital base changed your view?

John Riccitiello, CEO

So I feel like I'm stuck with one of those Abe Lincoln moments with it. I know the two-hour answer to that question, but I'll try to give you the two-minute answer. The first thing is the money in our bank account doesn't really affect at all our investment priorities. The capital is there, should it be necessary. But when we're looking at M&A and we're looking at our P&L investments in our business, they're not really affected by any sense of need to have the capital burn a hole in our pocket. It's just not at all the way we think. We're strong believers, Kim and I, in defining a pretty tight framework around where our capital should go and where expenses should go. And the consideration was never, we have extra money, so how do we spend it? So that's just not at all who we are. And I'm a pretty fundamental believer that constrained resources generate creativity. And creativity is what we run on; that's our fuel. The second thing is when you think about how we spend our money, I broadly categorize it in two broad ways of looking at it. One is we're building a specific application or enhancing a specific application that lives on top of our platform, and Reflect would be an example of that, but also network code, what we've done with collaboration, what we've done with our cloud content, and our delivery network; these are things that fit right on top. There's a very specific use case that's identified and enabled by that capability. And through that, we believe we generate more users and more revenue. Sometimes, it's a Create revenue stream; sometimes, it's an Operate revenue stream. Sometimes, it's both. So we essentially stack rank all of those ideas. And we invest in the ones where we have the right locus of talent and return expectations to make us feel good about making that investment. The second area we invest is a broad and less easy to answer your question around raw capability. And that is about the underlying performance of the engine, the underlying data capability and AI capability behind our Operate Services. In a way, maybe the second one is learning how to make a new thing in a fast-food restaurant. The first one is getting a college education. It's not as obvious that there's an instant return. But one of the benefits, at least for me and so many on our team, is we spent decades on this type of technology and understand, by a way of example, that our DOTS technology won't yield an immediate improvement in our near-term revenue prospects that is significant. On the other hand, it's exactly the way our business needs to be built in the sort of 2023, 2024, 2025 timeframe, that we won't be sitting on legacy code with a material deficit in terms of what we have to dig out of. In other words, we're future-proofing our business. Some of what we've done, this generation, we've been spending for two years, by a way of example, to support the M1 hardware that Apple announced and credited us just this week, and supporting both PlayStation 5 and the Xbox Series X and S, working with over 60 development studios on the console launches, lots of launch titles built on Unity. None of that yields an instantaneous return for us. What it spells for us is higher market shares next year and the year after. And so what we have to get right in Unity always is a combination of that which drives a near-term attach to new revenue streams that we can articulate and identify, and second, that what lifts the whole boat, data engineering, raw capability, and platform support; it sets up market share growth two and three years out. And we balance both of those to yield what we believe is the best possible outcome, driven by a combination, I will admit, of financial considerations and ego around market share. We like to grow.

Brad Zelnick, Analyst

Thank you for the very thorough answer to my question. That’s it for me, guys.

Operator, Operator

Great, thanks Brad. Bhavan, can you provide insights on William Blair?

Bhavan Suri, Analyst

Great, and congratulations! I want to emphasize that it was a really strong quarter for all of you and the team. I'd like to discuss a couple of more tactical aspects. Although I usually steer clear of tactical questions, I’m interested in your perspective on Roblox. I would like to know how you view Roblox in relation to the Unity platform and how investors should approach it. Some high-level insights on that, and perhaps a few more details would be very helpful. I have a quick follow-up as well.

John Riccitiello, CEO

That's probably my favorite question today, so thank you for asking. One thing we haven't addressed in our roadshow or investment presentation is the extensive list of growth opportunities we see in our business. We've focused on the opportunities that are currently within reach, which we can clearly define and measure in terms of scale, backed by a product fit that validates our case. Additionally, there are very few professional development tools that effectively engage consumers. Photoshop is among the rare tools that has gained significant traction with consumers. This success is due to the perfect combination of several factors occurring simultaneously. For Photoshop, smartphones have placed digital cameras in everyone's pockets—a convenience we didn't have before mobile phones. Alongside this, platforms like TikTok, Instagram, and Facebook have turned photos into vital currency for social interaction. Consumers needed a tool, and Photoshop filled that gap, creating a substantial business that extends beyond its initial professional context to effectively serve consumers. We have a similar opportunity at this moment. I truly believe that as we continue advocating for a world with more creators, our 1.5 million monthly active users will grow to hundreds of millions using Unity monthly, a significant portion of whom will be consumers. These consumers want tools to create better videos for TikTok, Instagram, or Facebook, where real-time 3D can enhance their visibility and engagement. We fully recognize this opportunity, which complements the strategy we've outlined regarding our investment thesis. You'll see us increasingly focus on this consumer opportunity in the coming quarters and years. Regarding Roblox, it's one of several examples that support our thesis.

Bhavan Suri, Analyst

No, it's helpful. And my 10-year-old is a customer of Unity. So I'll leave it at that. I'll ask my next question really. Quick follow-up on ASPs. You increased price for the first time. I'd love to understand what customers thought about it. Was there any pushback? And then I know you really said we don't want to do it again. But for the value you add, there's the opportunity to increase price given what you provide a ton of value. How do you think about that strategically?

John Riccitiello, CEO

Well, I mean the honest truth is I think we've got a situation where we can probably double the price and lose 2%, 3%, 5% of our users. If my number 1 priority was to serve our investors first, I would do just that. But that's not my first priority. My first priority is to serve you in the long run. And my strong view is real-time 3D is going to be without doubt the largest form of media on the planet. Most games are built that way today. But very few of the movies that you watch, very little of the social media. You don't go to your doctor and look at a real-time 3D model of your heart; you should. I can give you dozens of use cases that will move into the arena of real-time 3D. And if I start framing for you what I see on the horizon with some of the hardware, you will believe me even more. So I believe we have a market that will double, double, and double again. And I believe we have an opportunity to establish for Unity north of a 75% or 80% market share in the fullness of time. And the best use of our mind time and the best use of our investment is to build towards that outcome. Yes, pricing is easy, and yes, we will do it at some point, but I've watched short-term greed lead to lesser long-term outcomes. And I want to focus on the right long-term outcome to best serve our customers, our employees, and our shareholders.

Operator, Operator

Ryan from Bank of America Merrill Lynch, are you there? Alright, we'll come back to Ryan. Mario? Mario Lu from Barclays.

Ryan Gee, Analyst

Hey, guys, thanks for taking the question and congratulations on the first quarter out of the gate. This is more of a longer-term one for John and then I have a shorter-term one for Kim. So Unity really kind of stands out in the gaming space with the seat license business model. And I definitely appreciate those benefits. But one of the most common questions we get is, why doesn't Unity command a larger share of the economics for mobile games as you think about in-game transactions? I know Kim touched a little bit on this in her prepared remarks. But how much consideration do you and the Board give to a business model that will allow you to capture, not just Unity ad revenue, but perhaps total revenue by developers?

John Riccitiello, CEO

So you should have been in my last Board meeting; it was a central point. And there's parts of that Board meeting I can share with you and parts of it that I can't. So you're correct in saying that our take rate in gaming overall is not high. It's about 0.4%. When I talk to people in the industry, they have a mental picture that it must be at least 2%, 3%, 5%, 10%. I don't think they're wrong. I'm not telling you I can get there tomorrow. I have the benefit of having been involved in publishing north of $40 billion worth of games in my life. And I tell you, the one thing I hated more than anything was a royalty model or a rev share to a toolmaker. In fact, I blew every deal up that ever looked like that. And I was on the buy side of Unity many years ago for their first commercial customer and encouraged them not to do that. It's a particularly unfriendly model when it comes to content-creating tools. You don't want to give Photoshop a royalty on your photo if it ends up in some large social media outlet; you don't feel like you should owe them a percent. But suffice it to say, if you take a look at what we're trying to do with now cloud content delivery, what we're doing in hosting, what we're doing on monetization, what we're doing, and you'll see many more tools, that will allow us to generate new users within our development teams to bring more revenue onto the platform. I have every ambition to do exactly what I said in the roadshow. As I said, I believe we can increase our business in gaming as much as 10x. And that's what we're after. So for clarity, I 100% agree with the sentiment, and I want to get there one brick at a time over the course of the next handful of years.

Kim Jabal, CFO

Sure, I can take that one. We're not going to provide those specific metrics every quarter. I would direct you to the S1 where the overlap was 55% of our customers over $100k that are using both Create and Operate. This will continue to be a growth driver and is linked to the expansion rate, which, as you saw, was very healthy this quarter. You should assume that the strength of the platform and the real growth driver is the expansion of our customers across Create and Operate, whether they start with Create and then move to Operate or the other way around. We continue to see this trend into Q3.

Operator, Operator

Okay. Now Mario, if you're around. Mario Lu with Barclays.

Mario Lu, Analyst

Great. Congrats on the quarter. And thanks for taking the questions. So the first one is on gaming. So Unity, we all know, you guys are pretty strong within mobile and more casual titles like Among Us and Fall Guys, with those two titles reaching the top of the Twitch charts in recent months. With that being said, the next-gen titles, the PS4 launch today, the Xbox launched two days ago, so can you frame what your thoughts are around the next-gen console? Whether Unity is better positioned within gaming within this cycle compared to the last?

John Riccitiello, CEO

So yes. Last cycle, if you broke the market down into Xbox, Nintendo, and Sony's platform, our respective market shares were in the 30 to 40 on Sony and Microsoft, and about 70 on Nintendo in terms of the content that was built for the platform. If you further added a dimension to the market share graph and said, split out the AAA from the AA, split out the network titles or the live titles from the stuff that has its own television budget in terms of marketing. Of those titles, the AAA, the Grand Theft Autos of the world, the Assassin's Creed, Battlefield, FIFA, Call of Duty, these titles totally dominate the charts on console. The vast majority of them, 90% or so, are built on first-party or in this case, third-party tech, meaning it's the game engine from Activision, the game engine from Take-Two, the game engine from Ubisoft, or Electronic Arts. So against that backdrop, neither our competitor, Epic with Unreal, nor we have a material business on the AAA end. And they were ahead of us in this cycle, probably 3x our position, and neither of them are in double digits. And so we are both rounding errors with AAA, but they were a bigger rounding error than we are. We've been working with Sony and Microsoft for more than two years on this generation. We're working with—we don't have attribution rights for all of this because some of the stuff is unannounced. But on the Xbox Series X and S, 7 of the titles that were announced slate titles were built in Unity. On the PlayStation side, we're not allowed to even give you the number, but I can tell you that over 60 studios will have 60 studios release titles for PlayStation 5. And if you included Quest, which I'm now starting to see as the early innings of the beginnings of an AAA title, it's almost 70% to 80% of the Quest titles were made with Unity. And I think we're in position on console to gain materially in this cycle, but I don't think it's going to be over and out. I think this cycle intellectually or emotionally is still defined by the AAA. My sense is that AAA will probably finish the cycle with the principal titles, somewhere between 6 and 7 out of 10 being homegrown tech, and the balance split between Unity and Unreal. And while that may not sound like the most optimistic thing in the world, you wouldn't have put us in the sentence last time around. So we are gaining on all fronts, and we expect to continue to gain on all fronts. But when you're coming from no AAA and a good position on the AA to a much stronger position on AA and the beginnings of a meaningful position on AAA, that's good progress.

Mario Lu, Analyst

Got it. That's very helpful. And then just have a follow-up on the fourth quarter guide. So I believe on the high end, on revenue, it's guiding for 9% sequential growth versus 20% historically in the fourth quarter. So I think, Kim, you mentioned this in your prepared remarks, that player engagement is expected to fall a bit in the fourth quarter, and there might have been a pull forward of demand. But I guess, when you consider the second wave of COVID potentially in the west, why do you think that would be the case? Is there anything else embedded in there? And then any additional color you can provide on the 4Q guidance by segment? Thank you.

Kim Jabal, CFO

Yes. John, let me take that one.

John Riccitiello, CEO

Please.

Kim Jabal, CFO

Several factors are at play. First, comparing Q3 to Q4, Q3 was one of our strongest quarters, making it a challenging comparison. It's important to clarify that we do not expect user engagement to decrease. Typically, we would anticipate a significant seasonal increase in engagement during this period, tied to end-user activity. As John mentioned earlier, users are already at home and engaged at unprecedented levels. Thus, our Q4 projections assume that the usual holiday seasonal uptick has already occurred, and engagement is already at levels that would typically represent an increase. This assumption has been factored into our Q4 guidance.

John Riccitiello, CEO

Another thing to keep in mind is that we are in the middle of a significant period, which we've factored into our guidance as accurately as possible. When console cycles first emerge, they frequently enhance the industry overall. Typically, heavy spenders in mobile are also console users. Therefore, we may see a shift in gaming hours or game consumption towards consoles this quarter, provided they can obtain them. I still don’t have a PlayStation 5; I have my Xbox, and my PlayStation is supposedly on the way, with my R&D team receiving theirs first. Sony and Microsoft have executed remarkably well with their launches. They have clearly learned quickly from past cycles. I have never witnessed such strong launch lineups. I remember the PlayStation 2, where you primarily had a firework simulator with nothing else to do. You bought it because it looked good under the TV. Currently, I believe they have maximized every opportunity with their brilliant launches. Over time, we will benefit from that due to our larger position in the market. However, in the short term, I anticipate that the focus around this cycle and holiday will center on AAA games and consoles.

Operator, Operator

Andrew Uerkwitz at Oppenheimer, are you on?

Andrew Uerkwitz, Analyst

John, if you have a 3080, I'll trade you my PlayStation. I can't find those anywhere.

John Riccitiello, CEO

If I don't have a better contact for that, I would be embarrassed. But I'm not going to a retail store; I mean, who would have a chance? It’s not all day.

Andrew Uerkwitz, Analyst

My question is about the recent big games developed on Unity. I found it interesting that some of them did not utilize all of your Operate tools. I'm curious why a developer would choose to use your Create tool to build a live service game but not incorporate tools like Unity Vivox or some of your other Operate offerings.

John Riccitiello, CEO

I mean I wish it were the way you imagine it, and it will be the way you imagine it in time. So the life in a game development studio, how do I describe this? There are different chiefs responsible for virtually every one of the decisions today around hosting, voice, analytics, game development, whether you plug in special tools to augment a piece of a game engine. And those chiefs in terms of the titles that are being introduced now made their decision on game engine and hosting probably two years ago. So the strength of our push to get people to buy against the full platform is a lagging indicator of how well we're doing when you look at the titles being released today. So I would argue that what we're getting in terms of the cross-sell on the titles released today is less than we're getting on what we're selling now for titles that will come in the future. So I see the progress. And of course, two years ago, we didn't have multitudes of these services. And so the answer to your question is we're gaining, but the gain is on something you can't see. And that's frustrating to me, but it doesn't go faster. Now there are some things that we're going to do that I think will give you a better understanding of why I have confidence in that working. So using, by way of example, our hosting service, our hosting service for no product release in the market today has ever been achieved as a consequence of building the game in Unity, signing up for hosting, and launching the game on Unity's back end. That hasn't happened once yet. We're in the same shop. We sell them, and they buy our hosting service. We're starting to get sales on just that model now. A big part of our articulated public roadmap is networking code. And we have a very rich strategy around networking that I will not dive into today. But trust me, it's a very complex subject. That networking code is the bane of most game development studios. It is hard. It is irritating. They all build it custom with a rambling set of tools available from a variety of suppliers. That will be a push-button in the editor for many use cases in the 2021 timeframe. That push-button will make it incredibly easy for testing 1, 2, 5, 10, 15 people on your team using Multiplay hosting. By the time anyone sees an AWS, a GCP or whoever else we might be competing for the back end on that particular game, by the time they're aware this game exists, they've already been running on Unity for a long time. And so we have a lot of advantages coming from our position on the editor and being able to pull them together in one service. And that's exactly what we're doing, is we're setting up an end-to-end service to support our customers because we think we can do it better than a set of solutions that they might pick one at a time from different sheets on different teams. So thank you for thinking of us as the platform that we are but have yet to prove as much as I know we can and will in the coming years.

Andrew Uerkwitz, Analyst

I appreciate the idea of everyone being a creator. As I consider games and society, I'm curious about the monetization opportunities in the Metaverse. Is it primarily on the creation side, the operation side, or both? How should we envision the future of these platforms?

John Riccitiello, CEO

Well, so you mentioned Metaverse. I'm just going to start by putting a little pin in that. I'm a giant believer in the Metaverse. I'm also a giant believer that it's already here. Today, I played a couple of games. I read the news about the political environment. I read a lot of some news that's going on in some of our markets around the world. I communicated on Zoom, Slack, email. I got WhatsApp notices from notes from a bunch of my folks in Asia, and I made a cell phone call. And I visited a couple of dozen websites. I'm already in the middle of the Metaverse. What's going to change in years to come is that Metaverse will be increasingly real-time 3D. I saw some of Unity's future roadmap products for showing exactly how your Metaverse can collide with my Metaverse in this environment that I think will yield the answer to your question, which I will now finally give you. The answer to that question is where we're going to generate revenue? We have a lot of growth on seats, in ties the teams that are building in Unity. The opportunity is borne out of the fact that in a typical team, if it has a couple hundred people, we might have 70 seats. And we have the opportunity to grow with that team up to 200 seats. And our press there is we get network engineers we don't have with our networking code. We get artists as we put out more on the side of visual scripting. Our Collaborate software will encourage people to get to 100% of their seats on Unity. And those teams are growing. And then there's the other half of the teams we don't have. And so there's a lot in seats. We're also creating something that I'm not going to take a ton of time to dive into in a moment, but one-time applications built on top of Unity. Think of Reflect for game developers that would be incrementally sold to them for content creation. And so we have more tools coming to support the content creators. And if we are, I don't know, a quarter penetrated or a fifth penetrated against the current opportunity, that we have a realistic, achievable near-term. On the Create side, we're a couple percent or 5% penetrated on the amalgam of all things Operate. And so we expect a lot of market share growth on the Operate side. Hence, my sense that we can still 10x our business in gaming.

Operator, Operator

Okay. Brent Bracelin?

Brent Bracelin, Analyst

And I'm going to start actually with Kim and then a quick follow-up for John. Kim, on the Create subscription revenue side, it was surprisingly strong, pretty healthy acceleration to what, 46% growth. How much of the acceleration was driven to seat expansion in the gaming side of the business or some new gaming big wins? Or was it predominantly tied to beyond gaming and some new wins there? Just any color on what drove acceleration in that subscription component of the business.

Kim Jabal, CFO

I think it's important to take a moment to recognize that we experienced a slight impact on the Create side due to COVID challenges, starting in Q1 in Asia and continuing into Q2. As we transition from Q1 to Q2, we noticed an improvement, partly attributed to the addition of Finger Food to our portfolio, which contributed to growth within verticals. By the time we moved from Q2 to Q3, we saw a significant recovery. In response to your inquiry, the growth came from both gaming and new verticals. We encountered a slowdown in Q1 and Q2 overall, where larger, more complex deals took longer to finalize. Specifically regarding gaming, developers had to adjust to incorporating high-performance machines into their environments amid the COVID changes. However, by Q3, we experienced a recovery in seat growth and pipeline across both gaming and new verticals. Additionally, as John mentioned, we released two versions of Reflect in the quarter, which supported vertical growth. We will continue to launch these applications to enhance that growth. To directly answer your question, we are seeing growth and an acceleration in that growth across the board in Q3.

Brent Bracelin, Analyst

Good to hear. Is this the new normal? Or do you think this is just a bit of a catch-up, too? Or a little too early to say?

Kim Jabal, CFO

Well, I think we believe we will continue to have strong growth. So I'm not sure exactly how to answer that question, but some of it is yes, catching up from maybe delays that we had in Q1 and Q2. But it's also continued strength. And for all the reasons that John actually just spoke about on the gaming side, as we've built out across teams, new use cases, artists, networking code. And then on the vertical side, as we continue to expand across different verticals, adding new customers and developing these products, these applications that are really helping to drive the growth in verticals.

John Riccitiello, CEO

To elaborate further, Kim and I like to emphasize that we anticipate significant long-term growth. At times, it can be challenging for us to predict what will happen in the next quarter, and especially two quarters ahead. This is because our business presents numerous opportunities, and we do not aim to portray ourselves as entirely predictable. While some aspects of our business continue to evolve, we expect our considerable new product growth to propel us into the future. We foresee strong long-term growth, although it can be challenging to provide precise day-to-day insights.

Brent Bracelin, Analyst

That's helpful. John, just a quick follow-up here. My Xbox did arrive yesterday as well, too. But I'm doubtful that my 10-year-old is going to hop off his Minecraft and Roblox, and now this new Among Us app, that’s very popular with his friends. My question has to do with downloads. 3 billion monthly application downloads, I think in June. Now you're talking about 5 billion application downloads in September. That suggests downloads are accelerating faster than revenue. And I think you touched on this a little bit before, but how should we think about app download momentum? Is that a leading indicator that we're seeding the market with future long-tail opportunities to monetize? And now it's on you to figure out how to monetize it? Just help us understand that acceleration in downloads that we're seeing, that's growing faster than revenue and the opportunity to monetize it long term.

John Riccitiello, CEO

I'm going to start by talking about children if that's okay. I remember visiting Disneyland with my daughters when they were young, and they could spot characters from far away and name them, singing songs from all the princess movies. They've moved on from that phase now. I believe that if your kids are engaging with Minecraft and Roblox in ways that involve content creation, they are the consumers of the future. They will want to transition to tools that are simpler than the current Unity Editor. Look at what we've achieved with LEGO and Reflect; they provide a simplified experience for content creators. I feel confident that there's a significant opportunity there, even if you disagree with me. I am convinced that we can tap into this in the coming years, as there will come a time when they want to evolve into more powerful and capable tools, moving away from simpler options. Regarding the 5 billion downloads statistic, while it may sound surprising, that number is actually the average for this year. We've witnessed notable increases, likely influenced by COVID, as people download more apps but also remove them. However, we haven't observed a corresponding increase in monthly traffic. It seems that many users are experimenting with different applications, which is a positive sign. This is a healthy indicator for us, and it shows that Unity is well-positioned, with little competition in our area. This number is remarkable, surpassing even large companies in terms of monthly app downloads. We stand out in the market based on how many applications are actively downloaded globally; however, simply being downloaded multiple times on a device doesn't necessarily add more value. Still, it highlights our market share, especially for the primary game being downloaded worldwide; there's truly nothing else like Unity.

Brent Bracelin, Analyst

Thank you.

Operator, Operator

And last but not least, Tom Roderick.

Thomas Roderick, Analyst

Outstanding. All right. Hi, John, hi, Kim. It's great to see you. Great to hear from you. And Richard, if no one else is going to say it, I'll be the one. The gaming chair is electric. Just...

Operator, Operator

You like that, yes.

Thomas Roderick, Analyst

The earnings calls would have been more comfortable. Well done. John, I wanted to briefly address the commercial side of Create. I know Forma is very early, but I believe it's an excellent use case that adds another element to what 3D offers. Automotive has been a strong starting point for you on the commercial side. I would love to hear more about how the e-commerce shopping aspect of commercial may be changing the use case for 3D. Carvana is transforming the car buying and selling experience, and they are incorporating a lot of 3D technology themselves. Please discuss how this might apply to automotive or luxury goods and how the use case is evolving in a way that's helping Create gain traction beyond gaming.

John Riccitiello, CEO

Firstly, Forma is currently in development for a new version that aims to enhance the existing Forma product. It's impressive how many companies engage in selling to others, a process that historically involved in-person interactions such as meetings and demonstrations to persuade potential buyers. I firmly believe that the market for sales is substantial and here to stay. Furthermore, I don't anticipate a return to a solely in-person sales approach. We envision that Unity can be effectively utilized in Forma and its upcoming companion product, enabling sales through platforms like Zoom or our application more effectively than traditional in-person methods. That said, in-person interactions can still retain their value if desired. This represents an opportunity where Unity can supplant traditional marketing tools such as brochures, 2D demos, and videos. Whether you are selling a hospital bed or a car, showcasing products in a real-time 3D interactive environment is superior. The potential is significant, and surprisingly, it requires minimal effort from our engineering team, who are very efficient. The workload involved is modest compared to the expansive market opportunities we see. This is the rationale behind Forma and its ongoing enhancements. Additionally, some of you may not realize that there’s a backend component that generates revenue when clients develop these solutions, like car configurators as one example. This creates a dual revenue model for us.

Kim Jabal, CFO

We are not providing guidance for next year, but I am optimistic about the strength of other parts of the Operate platform. Monetization is currently the largest area because it was the first, but we are seeing significant growth in Multiplay and Vivox. There are exciting opportunities as we explore other verticals for Operate solutions, which are just beginning to develop. I would say there is a direct correlation between end-user engagement and the monetization business, although it's somewhat looser with Multiplay. There is potential to expand the set of solutions within Operate and grow our customer base beyond just end-user engagement. This applies to monetization too, as we are adding new customers and increasing our market share. End-user engagement is one aspect driving growth, while our existing customers are using our solutions more extensively and we continue to acquire new customers. These represent additional growth opportunities. Importantly, we are also focused on expanding our product portfolio within Operate.

John Riccitiello, CEO

Yes. We just released, and we're getting some good early traction around content cloud delivery as an example. So we also continue to dimensionalize this with new services that are in large markets. And that's another example of a large market where we think we're competitively advantaged. I think we're kind of out of time. Are we not to close?

Operator, Operator

Yes, that's it. But thank you very much. And John, if you want to conclude, that would be great. And we'll see you guys in three months.

John Riccitiello, CEO

Thanks, all. It's great seeing you all.

Kim Jabal, CFO

Thank you.

Operator, Operator

Thank you.