Unity Software Inc.

Richard Davis, Welcome to the earnings call for unity technologies i'd like to remind participants that during this conference call will be making forward looking statements, including statements about goals business outlook. Richard Davis, Industry trends market opportunities expectations for future and financial performance and similar items, all of which are subject to risks uncertainties and assumptions, you can find more information about these risks and. and certainties in the risk factor section of our filings at sec.gov. Actual results may differ. We take no obligation to revise or update any forward-looking statements. We will also be discussing our non-GAAP financial measures today and reconciliations between our GAAP and non-GAAP financial results and discussions of limitations of non-GAAP financial measures can be found in our earnings press release. Relations website. With that, let me turn 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 will persist through the third quarter with minimal impact in the fourth. Second, we continue to perform very well in Create, both with our gaming customers and with our non-game digital twins business, where we saw meaningful growth, a trend we expect to continue. With a 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 and create was offset by challenges and operates monetization business. Non-gap 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 very large opportunity in front of us while improving non-gap 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 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 modernization 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. Louise 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 the 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 in 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 that thoroughly addressed 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 pinpoint are for sure our original plan. We understand the problems and we're 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 and Warner 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 3 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. And in gaming, this data has proven to be the most relevant for advertising. We have strong conviction of the 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 4 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 multiplayer business. Since its beta launch in October, we've seen within 74,000 organization signups with over 68K 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 Chrome OS 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 TechStream, enabling game customers that are early in their production lifecycle with more tools for editor extensibility, productivity, platform optimizations, rendering capabilities, performance insights, and other key new features. Unity is the leading tool and service for game creators of any size to deliver their ambitions. The flexibility and multi-platform capabilities we provide are often critical unlocks for our customers and 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 Raman VR has been a runaway hit on virtual reality. This title is a multiplatform, massively multiplayer online role-playing game for virtual reality where players explore an anime-inspired world on MetaQuest, MetaRift, PlayStation VR, and standalone VR devices. Raman 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 a 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 Siberia, the World Before. The fourth edition of the Siberia series, it launched a 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 pipelines. Many large press publishers use Unity 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. Status Pro 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 real 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 in what they would do next. As you may have seen with a trailer for Avatar 2 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 WetaFX 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 Weather 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 entertainment. We see significant traction with these tools in games like Halo Infinite and movies like Dune. Users of our Ziva Dynamics technology and winners of 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 signups and a multitude of cloud uploads for our beta of Ziva faces. The 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 100K, 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 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 intelligent and interactivity into a 3D star avatar that'll be more akin to a digital butler. Additionally, the MBOS 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 optimize 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 twin solutions across several new categories. From one of the largest energy companies in the world that is deploying our digital twin products across the enterprise to run their own downstream operations more effectively, to an iconic luxury brand that is leveraging Unity to market a differentiated digital experience that can only be done in real-time 3D. Lockheed Martin is a model example of land and expanded 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, and guidance and collaboration. We're also making a difference in enabling how creators work. Parsec and SynSketch 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 in growth and 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 monetization 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. But 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 made 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 operating business lives in an exceptionally large market. We have a material data advantage in our modernization 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 commuting 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 original 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 a double, but more like 5 to 10x 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 and 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 in added resilience and redundancy. And since all of you on this call have to publish your models, the question becomes exactly when Operate will cover and what that trajectory will look like. It is always harder to forecast a change in trajectory than a continuation of one. Our guidance reflects your best estimate of that curve. And with that, let me turn the call to Luis.

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 operate business negatively impact our first quarter results and are expected to expected to negatively impact our business in the second and third quarters with minimal impact to the fourth quarter, I will provide for the details in a minute. In the first quarter of 2022, we delivered revenue of $320 million of 36% year over year. Create performed strongly with revenue of $116 million of 65% from a year ago. Operate softened with revenue of $184 million of 26% year over year. Strategic partnerships and other delivered $20 million in revenue of 11% from a year earlier. We delivered at the high end of our guidance range with creates over performance, 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 what affects in cost of goods sold. Excluding this impact, 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 include 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 the last year's first quarter to minus 7.2 this quarter. cash flow from operations was 101 million, which includes WETA's FX 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, all 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 consider 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 revenue growth. We quantify 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 refaces 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 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 for our internal plan. We believe this will make us a stronger company short and long term. This savings will not have much of an impact in our second quarter, but it 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 non-GAAP operating loss in the second quarter between $62 and $64 million. For the full year, we expect non-GAAP operating loss between $60 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.