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OFFON

UNITY SOFTWARE INC.

(U)
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UNITY SOFTWARE : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

05/12/2021 | 04:10pm EDT
Please read the following discussion and analysis of our financial condition and
results of operations together with our condensed consolidated financial
statements and related notes included under Part I, Item 1 of this Quarterly
Report on Form 10-Q. The following discussion and analysis contains
forward-looking statements that involve risks and uncertainties. When reviewing
the discussion below, you should keep in mind the substantial risks and
uncertainties that could impact our business. In particular, we encourage you to
review the risks and uncertainties described in "Part II-Other Information,
Item 1A. Risk Factors" included elsewhere in this report. These risks and
uncertainties could cause actual results to differ materially from those
projected in forward-looking statements contained in this report or implied by
past results and trends. Forward-looking statements are statements that attempt
to forecast or anticipate future developments in our business, financial
condition or results of operations. See the section titled "Note Regarding
Forward-Looking Statements" in this report. These statements, like all
statements in this report, speak only as of their date (unless another date is
indicated), and we undertake no obligation to update or revise these statements
in light of future developments.
Overview
Unity is the world's leading platform for creating and operating interactive,
real-time 3D ("RT3D") content.
Our platform provides a comprehensive set of software solutions to create, run,
and monetize interactive, real-time 2D and 3D content for mobile phones,
tablets, PCs, consoles, and augmented and virtual reality devices.
Our platform consists of two distinct, but connected and synergistic, sets of
solutions: Create Solutions and Operate Solutions. Our Create Solutions are used
by content creators-developers, artists, designers, engineers, and architects-to
create interactive, real-time 2D and 3D content. Content can be created once and
deployed to more than 20 platforms, including Windows, Mac, iOS, Android,
PlayStation, Xbox, Nintendo Switch, and the leading augmented and virtual
reality platforms, among others. Our Operate Solutions offer customers the
ability to grow and engage their end-user base, as well as run and monetize
their content with the goal of optimizing end-user acquisition and operational
costs, while increasing the lifetime value of their end users.
We launched our first game development engine in 2004, bringing together a set
of tools, such as rendering, lighting, physics, sound, animation, and user
interface, that were designed to address the challenges faced by most game
developers. Prior to Unity, developers primarily created these tools
individually and repetitively across different target platforms, which was an
expensive and time-consuming process. Unity made game development easier and
faster.
In the three months ended March 31, 2021, we built upon our history of
innovation by achieving a number of milestones that secured our position as the
leading platform for creating and operating interactive, real-time 3D content
including those identified below.
•Our new customers in the first quarter span a wide range of industries. We saw
new customers in household appliances, automotive, healthcare, aerospace, and
government as well as a multinational retailer. One such customer - VirtraMed -
will standardize development on Unity for both existing and future products.
VirtraMed allows surgeons, physicians, and medical educators to train in
risk-free virtual environments and simulations for different diagnostic and
therapeutic procedures.
•Fortune 50 DIY retailer to employ Unity RT3D. Each week over 300,000 Lowe's
employees serve over 20 million customers from over 2,000 locations in the
United States and Canada. Lowe's is a long-standing user of Unity technology,
but this quarter, its Lowe's Innovation Labs unit engaged with our Accelerate
Solutions group to test the ability of RT3D to optimize workflows and processes
for their associates.
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•KING released its first title built solely on Unity. In March 2021, the makers
of the game Candy Crush, KING, released the latest in the Crash Bandicoot
franchise, Crash Bandicoot on the Run, built entirely on Unity. As its first 3D
mobile title, KING's highly ambitious goals demanded that they be intentional
about choosing a game engine. They chose Unity to bring a beloved franchise to
mobile with console-quality graphics and playable on a broad array of devices.
•We aim to power the next generation of in-car experiences. We are collaborating
with HERE Technologies to build the next generation of in-car experiences
through embedded, automotive human machine interfaces with real-time 3D graphics
capabilities. The collaboration aims to deliver a new range of high end, dynamic
mapping and infotainment experiences such as autonomous driving, simulations,
city planning and digital twin through a combination of automotive-grade map
data and services with Unity's RT3D platform.
•We delivered on our commitment to game developers with the release of updated
products and innovation. Following the product commitments made in Summer 2020,
we continued to deliver on our promise of stability and ease of use with the
2020 Long Term Support version of the editor. Concurrently, we released the
2021.1 Tech Stream geared towards users who are early on in development with
experimental versions of new and innovative features giving developers the
freedom and flexibility to explore these new capabilities.
We continue to invest in research and development and to pursue selective
acquisitions and partnerships in order to enhance and expand our platform.
Impact of COVID-19
While our total revenue, cash flows, and overall financial condition have not
been adversely impacted to date, the COVID-19 pandemic has caused general
business disruption worldwide beginning in January 2020. The full extent to
which the COVID-19 pandemic, including any new strains or mutations, will
directly or indirectly impact our business, results of operations, and financial
condition will depend on future developments that are highly uncertain and
cannot be accurately predicted. Although we may continue to experience a modest
adverse impact on our sales of Create Solutions, our pipeline of customer
opportunities for our Create Solutions was largely back to normal levels by the
end of 2020, as well as our Strategic Partnerships. Additionally, we have seen
an increase in demand for our portfolio of products and services within Operate
Solutions following the implementation of shelter-in-place orders to mitigate
the outbreak of COVID-19, which has resulted in higher levels of end-user
engagement in Operate Solutions and an increase in revenue, along with a
decrease in operating expense due to materially reduced travel and spending on
events and facilities. However, this increased demand for our Operate Solutions
and expense reduction will likely moderate over time, particularly as vaccines
are becoming widely available, and as shelter-in-place orders and other related
measures and community practices evolve. Further, as certain of our customers or
partners experience downturns or uncertainty in their own business operations or
revenue resulting from the COVID-19 pandemic, they may decrease or delay their
spending, request pricing concessions, or seek renegotiations of their
contracts, any of which may result in decreased revenue for us. In addition, we
may experience customer losses, due to factors including bankruptcy or our
customers ceasing operations, which may result in an inability to collect
receivables from these customers. In response to the COVID-19 pandemic, we are
also requiring or have required substantially all of our employees to work
remotely to minimize the risk of the virus to our employees and the communities
in which we operate. We are currently planning for our employees to return to
in-person offices later this year, however our plans may change if the number of
COVID-19 cases rises where our offices are located, and we may take further
actions as may be required by government authorities or that we determine are in
the best interests of our employees, customers, and business partners.
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The global impact of the COVID-19 pandemic continues to rapidly evolve, and we
will continue to monitor the situation and the effects on our business and
operations closely. We do not yet know the full extent of potential impacts on
our business or operations or on the global economy as a whole, particularly as
the COVID-19 pandemic persists. The rollout of vaccines and the reduction of
COVID-19 cases globally could affect the seasonality of our business or boost
global GDP growth, which could positively impact our business. However, the
return of more in-person activities will result in an increase in our expenses
and could result in a range of impacts to our customers, which could impact our
business. Given the uncertainty, we cannot reasonably estimate the impact on our
future results of operations, cash flows, or financial condition. For additional
details, refer to the section titled "Risk Factors."
Key Metrics
We monitor the following key metrics to help us evaluate the health of our
business, identify trends affecting our growth, formulate goals and objectives,
and make strategic decisions.
Customers Contributing More Than $100,000 of Revenue
We have a history of strong growth in our customer base. We focus on the number
of customers that generated more than $100,000 of revenue in the trailing 12
months, as this segment of our customer base represents the majority of our
revenue and revenue growth. We expect that trend to continue. We define a
customer as an individual or entity that generated revenue during the
measurement period. A single organization with multiple divisions, segments, or
subsidiaries is generally counted as a single customer, even though we may enter
into commercial agreements with multiple parties within that organization. We
had 837 and 668 of such customers in the trailing 12 months as of March 31, 2021
and 2020, respectively, demonstrating our ability to grow our revenues with
existing customers, and our strong and growing penetration of larger
enterprises, including AAA gaming studios and large organizations in industries
beyond gaming. While these customers represented the substantial majority of
revenue for the three months ended March 31, 2021 and 2020, respectively, no one
customer accounted for more than 10% of our revenue for either period.
Dollar-Based Net Expansion Rate
Our ability to drive growth and generate incremental revenue depends, in part,
on our ability to maintain and grow our relationships with our Create and
Operate Solutions customers and to increase their use of our platform. We track
our performance by measuring our dollar-based net expansion rate, which compares
our Create and Operate Solutions revenue from the same set of customers across
comparable periods, calculated on a trailing 12-month basis.
Our dollar-based net expansion rate as of a period end is calculated as current
period revenue divided by prior period revenue. Prior period revenue is the
trailing 12-month revenue measured as of such prior period end and includes
revenue from all customers that contributed revenue during such trailing
12-month period. Current period revenue is the trailing 12-month revenue from
these same customers as of the current period end. Our dollar-based net
expansion rate includes the effect of any customer renewals, expansion,
contraction, and churn but excludes revenue from new customers in the current
period.
                                                       As of
                                         March 31, 2021          March 31, 2020
Dollar-based net expansion rate                       140  %              

133 %



Our dollar-based net expansion rate as of March 31, 2021 and 2020, was driven
primarily by the sales of additional subscriptions and services to our existing
Create Solutions customers, expanded usage among our existing Operate Solutions
customers, and improvements in cross-selling our solutions to all of our
customers. In the three months ended March 31, 2021 and 2020, increased usage of
Operate Solutions drove the improvement in our dollar-based net expansion rate.
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The chart below illustrates our strong relationship with existing customers by
presenting our dollar-based net expansion rate as of the end of each of the past
eight quarters.
                    [[Image Removed: unity-20210331_g1.jpg]]

Results of Operations The following table summarizes our historical consolidated statements of operations data for the periods indicated (in thousands):

                                                  Three Months Ended March 31,
                                                      2021                   2020
Revenue                                    $        234,772               $ 166,994
Cost of revenue                                      58,734                  31,868
Gross profit                                        176,038                 135,126
Operating expenses
Research and development                            154,015                  81,751
Sales and marketing                                  69,793                  43,259
General and administrative                           63,132                  37,553
Total operating expenses                            286,940                 162,563
Loss from operations                               (110,902)                (27,437)
Interest expense                                       (115)                   (132)
Interest income and other expense, net                1,565                 

1,856

Loss before provision for income taxes             (109,452)                (25,713)
Provision for income taxes                           (1,992)                  1,023
Net loss                                   $       (107,460)              $ (26,736)


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The following table sets forth the components of our condensed consolidated
statements of operations data as a percentage of revenue for the periods
indicated:
                                                 Three Months Ended March 31,
                                                       2021                  2020
Revenue                                                           100  %     100  %
Cost of revenue                                                    25         19
Gross margin                                                       75         81
Operating expenses
Research and development                                           66         49
Sales and marketing                                                30         26
General and administrative                                         27         22
Total operating expenses                                          123         97
Loss from operations                                              (47)       (16)
Interest expense                                                    -          -
Interest income and other expense, net                              1       

1

Loss before provision for income taxes                            (46)       (15)
Provision for income taxes                                         (1)         1
Net loss                                                          (45) %     (16) %


Revenue
We derive revenue from Create Solutions, Operate Solutions, and Strategic
Partnerships and Other.
Create Solutions
We generate Create Solutions revenue primarily through the sale of subscription
fee arrangements for the use of our products and related support services.
We offer subscription plans at various price points and recognize revenue over a
service period that generally ranges from one to three years. We typically bill
our customers on a monthly, quarterly or annual basis, depending on the size of
the contract. As a result of billing our customers in advance, we record
deferred revenue, and a portion of the revenue we report in each period is
attributable to the recognition of deferred revenue related to subscription and
support agreements that we entered into during previous periods.
We generate additional Create Solutions revenue from the sale of professional
services to our subscription customers. These services primarily consist of
consulting, integration, training and custom application and workflow
development, and may be billed in advance or on a time and materials basis.
Operate Solutions
We generate Operate Solutions revenue through a combination of revenue-share and
usage-based business models that we manage as a portfolio of products and
services.
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Our monetization products are primarily based on a revenue-share model. These
products were introduced in 2014 as our first set of Operate Solutions products
and currently account for a substantial majority of our Operate Solutions
revenue. We recognize monetization revenue primarily when an end user installs
an application after seeing an advertisement (contracted on a cost-per-install
basis), and to a lesser extent when an advertisement starts (contracted on a
cost-per-impression basis). Our revenue represents the amount we retain from the
transaction we are facilitating through our Unified Auction. Actions by
operating system platform providers or application stores such as Apple or
Google may affect the manner in which we or our customers collect, use and share
data from end-user devices. In June 2020, Apple announced plans to require
applications using its mobile operating system, iOS, to affirmatively (on an
opt-in basis) obtain an end user's permission to "track them across apps or
websites owned by other companies" or access their device's advertising
identifier for advertising and advertising measurement purposes, as well as
other restrictions. Apple implemented some of these changes in the fall of 2020
and announced others to come. In April 2021, Apple implemented its end user
opt-in permission requirement. The exact timing and manner in which Apple's
plans will be implemented and their effect on our revenue are not yet clear, but
we expect these changes to adversely affect our revenue from our monetization
products and potentially other Operate Solutions, and such impact could be
material.
We also provide cloud-based services to support the ongoing operation of games
and applications. These include application hosting services, as well as
end-user engagement tools and voice chat services. These services are generally
sold based on usage and billed monthly in arrears. Some of our usage-based
contracts include a minimum fixed-fee usage amount. We expect that our Operate
Solutions beyond monetization, including cloud operations and hosting services,
such as Multiplay, which we introduced in 2018, will grow as a percentage of our
revenue in the long term as we further scale newer products and services and as
we launch additional solutions for gaming customers as well as customers in
other industries.
Strategic Partnerships and Other
We generate Strategic Partnerships revenue primarily from partnership contracts
with hardware, operating system, device, game console, and other technology
providers. Typically, we recognize revenue from these contracts as services are
performed. These partnerships are typically multi-year software development
arrangements with payments that are either made in advance on a quarterly basis
or milestone-based. In addition, certain partners pay us royalties based on the
sales of applications sold on their platform that incorporate or use our
customized software.
We generate Other revenue primarily from our share of sales from our Asset
Store, a marketplace and scaled aggregator for software, content, and tools used
in the creation of real-time interactive games and applications, and from our
Verified Solutions Partners, which sell software and tools certified for quality
and compatibility with our platform.
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Our total revenue is summarized as follows (in thousands, except percentages):
                                        Three Months Ended
                                            March 31,                    Change
                                       2021           2020          Amount         %
Create Solutions                    $  70,387      $  46,696      $ 23,691        51  %
Operate Solutions                     146,578        104,368        42,210        40  %
Strategic Partnerships and Other       17,807         15,930         1,877        12  %
Total revenue                       $ 234,772      $ 166,994      $ 67,778        41  %


The increase in revenue in the three months ended March 31, 2021 compared to the
three months ended March 31, 2020 was substantially due to revenue growth among
existing customers. Create Solutions revenue growth was largely attributable to
an increase of new customers, as well as expansion of existing customers. Within
Operate Solutions, the substantial majority of our revenue growth was driven by
an increase in revenue per customer as customers increased their usage across
our Operate portfolio of products and services, due in part to the higher levels
of end-user engagement as a result of strong product and sales execution.
Cost of Revenue, Gross Profit, and Gross Margin
Cost of revenue consists primarily of hosting expenses, personnel costs
(including salaries, benefits and stock-based compensation) for employees
associated with our product support and professional services organizations,
allocated overhead (including facilities, information technology ("IT"), and
security costs), third party license fees, and credit card fees, as well as
amortization of related capitalized software and depreciation of related
property and equipment.
Gross profit, or revenue less cost of revenue, has been and will continue to be
affected by various factors, including our product mix, the costs associated
with third-party hosting services, and the extent to which we expand and drive
efficiencies in our hosting costs, professional services, and customer support
organizations. We expect our gross profit to increase in absolute dollars, but
we expect our gross profit as a percentage of revenue, or gross margin, to
fluctuate from period to period.
Our cost of revenue, gross profit, and gross margin are summarized as follows
(in thousands, except percentages):
                           Three Months Ended
                                March 31,                          Change
                           2021                2020          Amount          %
Cost of revenue   $               58,734    $    31,868    $    26,866      84  %
Gross profit      $              176,038    $   135,126    $    40,912      30  %
Gross margin                       75  %         81   %                     (6) %


Cost of revenue for the three months ended March 31, 2021 increased primarily
due to an increase of $15.7 million in personnel-related expense driven by a
$4.6 million increase in stock-based compensation expense primarily related to
the satisfaction of the performance vesting condition on outstanding RSUs upon
completion of our IPO, and an increase in headcount to support our Create
Solutions and Strategic Partnerships. IT hosting expense also increased by $8.3
million to support growth in our Create and Operate Solutions.
The year-over-year decline in gross margin decreased primarily due to an
increase in personnel-related costs to support our Create Solutions and
Strategic Partnerships, product mix of revenues, in addition to an increase in
IT hosting expense to support growth in our Create and Operate Solutions.
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Operating Expenses
Our operating expenses consist of research and development, sales and marketing,
and general and administrative expenses. The most significant component of our
operating expenses is personnel-related costs, including salaries and wages,
sales commissions, bonuses, benefits, stock-based compensation, and payroll
taxes.
Research and Development
Research and development expenses primarily consist of personnel-related costs
for the design and development of our platform, third-party software services,
professional services, and allocated overhead. We expense research and
development expenses as they are incurred. We expect our research and
development expenses to increase in absolute dollars and may fluctuate as a
percentage of revenue from period to period as we expand our teams to develop
new products, expand features and functionality with existing products, and
enter new markets.
Research and development expense is summarized as follows (in thousands, except
percentages):
                               Three Months Ended
                                   March 31,                    Change
                               2021           2020         Amount         %
Research and development   $  154,015      $ 81,751      $ 72,264        88  %


Research and development expense for the three months ended March 31, 2021
increased primarily due to an increase of $63.0 million in personnel-related
expenses driven by a $26.9 million increase in stock-based compensation expense
primarily related to the satisfaction of the performance vesting condition on
outstanding RSUs upon completion of our IPO and an increase in headcount to
support continued product innovation. In addition, IT hosting expense increased
by $7.6 million due to growing data and compute needs.
Sales and Marketing
Our sales and marketing expenses consist primarily of personnel-related costs;
advertising and marketing programs, including digital account-based marketing,
user events such as developer-centric conferences and our annual Unite user
conferences; and allocated overhead. We expect that our sales and marketing
expense will increase in absolute dollars as we hire additional personnel,
increase our account-based marketing, direct marketing and community outreach
activities, invest in additional tools and technologies, and continue to build
brand awareness. Our expenses may fluctuate as a percentage of revenue from
period to period.
Sales and marketing expense is summarized as follows (in thousands, except
percentages):
                            Three Months Ended
                                March 31,                    Change
                            2021           2020         Amount         %
Sales and marketing     $   69,793      $ 43,259      $ 26,534        61  %


Sales and marketing expense for the three months ended March 31, 2021 increased
primarily due to an increase of $22.0 million in personnel-related expenses
driven by a $10.2 million increase in stock-based compensation expense primarily
related to the satisfaction of the performance vesting condition on outstanding
RSUs upon completion of our IPO and an increase in headcount to support the
growth of our sales and marketing teams. Advertisement expenditures on various
social media platforms also increased $4.6 million.
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General and Administrative
Our general and administrative expenses primarily consist of personnel-related
costs for finance, legal, human resources, IT, and administrative employees;
professional fees for external legal, accounting, and other professional
services; and allocated overhead. We expect that our general and administrative
expenses will increase in absolute dollars and may fluctuate as a percentage of
revenue from period to period as we scale to support the growth of our business.
General and administrative expense is summarized as follows (in thousands,
except percentages):
                                  Three Months Ended
                                      March 31,                    Change
                                  2021           2020         Amount         %
General and administrative    $   63,132      $ 37,553      $ 25,579        68  %


General and administrative expense for the three months ended March 31, 2021
increased primarily due to an increase in personnel-related costs of $20.0
million, driven by a $15.3 million increase in stock-based compensation expense
primarily related to the satisfaction of the performance vesting condition on
outstanding RSUs upon completion of our IPO and an increase in headcount to
support the growth of our finance, accounting, human resources, IT, and legal
functions. In addition, IT expense increased $2.5 million due to an increase in
enterprise application license costs.
Interest Expense
Interest expense consists primarily of interest expense associated with our
Credit Agreement. Interest expense is summarized as follows (in thousands,
except percentages):
                           Three Months Ended
                               March 31,                     Change
                            2021             2020       Amount        %
Interest expense     $     (115)           $ (132)     $   17       (13) %




Interest expense and fees related to our undrawn credit facility were recognized
in the three months ended March 31, 2021 on our undrawn credit facility.
Interest Income and Other Expense, Net
Interest income and other expense, net, consists primarily of interest income
earned on our cash, cash equivalents, and marketable securities, amortization of
premium arising at acquisition of marketable securities, foreign currency
remeasurement gains and losses, and foreign currency transaction gains and
losses. As we have expanded our global operations, our exposure to fluctuations
in foreign currencies has increased, and we expect this to continue.
Interest income and other expense, net, is summarized as follows (in thousands,
except percentages):
                                               Three Months Ended
                                                    March 31,                    Change
                                                2021            2020       

Amount % Interest income and other expense, net $ 1,565 $ 1,856 $ (291) (16) %

Interest income and other expense, net, for the three months ended March 31, 2021, decreased primarily due to foreign currency remeasurement losses.

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Provision for Income Taxes
Provision for income taxes consists primarily of income taxes in certain foreign
jurisdictions where we conduct business. As we have expanded our global
operations, we have incurred increased foreign tax expense, and we expect this
to continue. We have a valuation allowance against certain of our deferred tax
assets, including net operating loss ("NOL") carryforwards and tax credits
related primarily to research and development. Our overall effective income tax
rate in future periods may be affected by the geographic mix of earnings in the
countries in which we operate. Our future effective tax rate may also be
affected by changes in the valuation of our deferred tax assets or liabilities,
or changes in tax laws, regulations, or accounting principles in the
jurisdictions in which we conduct business. See Note 14, "Income Taxes," of the
Notes to Condensed Consolidated Financial Statements.
Provision for income taxes is summarized as follows (in thousands, except
percentages):
                                  Three Months Ended
                                      March 31,                     Change
                                  2021           2020         Amount          %
Provision for income taxes    $    (1,992)     $ 1,023      $ (3,015)       (295) %


Provision for income taxes decreased primarily due to the tax benefit from
stock-based compensation activity in the three months ended March 31, 2021.
Non-GAAP Financial Measures
To supplement our consolidated financial statements prepared and presented in
accordance with generally accepted accounting principles in the United States,
or GAAP, we use certain non-GAAP performance financial measures, as described
below, to evaluate our ongoing operations and for internal planning and
forecasting purposes. We believe the following non-GAAP measures are useful in
evaluating our operating performance. We are presenting these non-GAAP financial
measures because we believe, when taken collectively, they may be helpful to
investors because they provide consistency and comparability with past financial
performance. In the future, we may also exclude non-recurring expenses and other
expenses that do not reflect our overall operating results.
However, non-GAAP financial measures have limitations in their usefulness to
investors because they have no standardized meaning prescribed by GAAP and are
not prepared under any comprehensive set of accounting rules or principles. In
addition, other companies, including companies in our industry, may calculate
similarly-titled non-GAAP financial measures differently or may use other
measures to evaluate their performance, all of which could reduce the usefulness
of our non-GAAP financial measures as tools for comparison. As a result, our
non-GAAP financial measures are presented for supplemental informational
purposes only and should not be considered in isolation or as a substitute for
our consolidated financial statements presented in accordance with GAAP.
Non-GAAP Gross Profit and Non-GAAP Loss from Operations
We define non-GAAP gross profit as gross profit excluding stock-based
compensation expense and employer tax related to employee stock transactions. We
define non-GAAP loss from operations as loss from operations excluding
stock-based compensation expense, employer tax related to employee stock
transactions, and amortization expense of acquired intangible assets. We use
non-GAAP gross profit and non-GAAP loss from operations in conjunction with
traditional GAAP measures to evaluate our financial performance. We believe that
non-GAAP gross profit and non-GAAP loss from operations provide our management
and investors consistency and comparability with our past financial performance
and facilitates period-to-period comparisons of operations, as these metrics
excludes stock-based compensation expense, employer tax related to employee
stock transactions, and amortization expense of acquired intangible assets,
which we do not consider to be indicative of our overall operating performance.
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Non-GAAP gross profit and non-GAAP loss from operations have limitations as
analytical tools, and you should not consider them in isolation or as a
substitute for analysis of our results as reported under GAAP. Some of these
limitations are:
•they exclude expense associated with our equity compensation plan, although
equity compensation has been, and will continue to be, an important part of our
compensation strategy;
•non-GAAP loss from operations excludes the expense of amortization of acquired
intangible assets, and although these are non-cash expenses, the assets being
amortized may have to be replaced in the future and non-GAAP loss from
operations does not reflect cash expenditure for such replacements; and
•the expenses and other items that we exclude in our calculation of non-GAAP
gross profit and non-GAAP loss from operations may differ from the expenses and
other items, if any, that other companies may exclude from this measure or
similarly titled measures, which reduces their usefulness as comparative
measures.
The following table presents a reconciliation of our non-GAAP gross profit to
our GAAP gross profit, the most directly comparable measure as determined in
accordance with GAAP, for the periods presented (in thousands):
                                                                            Three Months Ended
                                                                                 March 31,
                                                                       2021                        2020
GAAP gross profit                                            $                176,038       $          135,126
Add:
Stock-based compensation expense                                                5,117                      557
Employer tax related to employee stock transactions                             2,761                        9
Non-GAAP gross profit                                        $                183,916       $          135,692
GAAP gross margin                                                             75    %                  81    %
Non-GAAP gross margin                                                         78    %                  81    %


The year-over-year decline in non-GAAP gross margin was primarily due to higher
personnel-related costs to support our Create Solutions and Strategic
Partnerships, product mix of revenues, and increased hosting costs to meet the
demands and growth from our Operate Solutions business.
The following table presents a reconciliation of our non-GAAP loss from
operations to our GAAP loss from operations, the most directly comparable
measure as determined in accordance with GAAP, for the periods presented (in
thousands):
                                                          Three Months Ended
                                                               March 31,
                                                          2021           2020
GAAP loss from operations                             $ (110,902)     $ (27,437)
Add:
Stock-based compensation expense                          66,561          

9,691

Employer tax related to employee stock transactions       16,458            

155

Amortization of intangible assets expense                  4,459          

4,144


Non-GAAP loss from operations                         $  (23,424)     $ 

(13,447)



The year-over-year increase in non-GAAP loss from operations was primarily due
to higher personnel-related costs, driven by an increase in headcount across the
entire company to support the growth in the business, as well as an increase in
IT hosting costs to support growth in our Operate Solutions and our growing data
and compute needs.
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Non-GAAP Net Loss and Non-GAAP Net Loss per Share
We define non-GAAP net loss and non-GAAP net loss per share as net loss and net
loss per share excluding stock-based compensation expense, employer tax related
to employee stock transactions, and amortization expense of acquired intangible
assets, as well as the related tax effects of these items. Non-GAAP net loss per
share also adds back expense relating to deemed dividends representing excess
paid over initial issuance price to repurchase convertible preferred stock. We
use non-GAAP net loss and non-GAAP net loss per share in conjunction with
traditional GAAP measures to evaluate our financial performance. We believe that
these non-GAAP measures provide our management and investors consistency and
comparability with our past financial performance and facilitates
period-to-period comparisons of operations.
Non-GAAP net loss and non-GAAP net loss per share have limitations as analytical
tools, and you should not consider them in isolation or as a substitute for
analysis of our results as reported under GAAP. Some of these limitations are:
•they exclude expense associated with our equity compensation plan, although
equity compensation has been, and will continue to be, an important part of our
compensation strategy;
•they exclude the expense of amortization of acquired intangible assets, and
although these are non-cash expenses, the assets being amortized may have to be
replaced in the future and non-GAAP loss from operations does not reflect cash
expenditure for such replacements;
•as further described below, we must make certain assumptions in order to
determine the income tax effect adjustment for non-GAAP net loss, which
assumptions may not prove to be accurate; and
•the expenses and other items that we exclude in our calculation of non-GAAP net
loss and non-GAAP net loss per share may differ from the expenses and other
items, if any, that other companies may exclude from this measure or similarly
titled measures, which reduces their usefulness as comparative measures.
Income Tax Effects of Non-GAAP Adjustments
We utilize a fixed projected tax rate in our computation of non-GAAP income tax
effects to provide better consistency across interim reporting periods. In
projecting this non-GAAP tax rate, we utilize a financial projection that
excludes the direct impact of the non-GAAP adjustments described above, and
eliminates the effects of non-recurring and period specific items which can vary
in size and frequency. The projected rate considers other factors such as our
current operating structure, existing tax positions in various jurisdictions,
and key legislation in major jurisdictions where we operate. For the year ending
December 31, 2021, we have determined the projected non-GAAP tax rate to be
(22)%. We will periodically re-evaluate this tax rate, as necessary, for
significant events, based on relevant tax law changes, material changes in the
forecasted geographic earnings mix, and any significant acquisitions.
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The following table presents a reconciliation of our non-GAAP net loss and
non-GAAP net loss per share to our GAAP net loss and GAAP net loss per share,
respectively, which are the most directly comparable measures as determined in
accordance with GAAP, for the periods presented (in thousands, except per share
data):
                                                                        Three Months Ended
                                                                             March 31,
                                                                    2021                  2020
GAAP net loss                                                  $   (107,460)         $    (26,736)
Add:
Stock-based compensation expense                                     66,561                 9,691
Employer tax related to employee stock transactions                  16,458                   155
Amortization of intangible assets expense                             4,459                 4,144

Income tax effect of non-GAAP adjustments                            (7,337)                 (821)
Non-GAAP net loss                                              $    

(27,319) $ (13,567)

GAAP net loss per share attributable to our common stockholders, basic and diluted

                                $      

(0.39) $ (0.21) Total impact on net loss per share, basic and diluted, from non-GAAP adjustments

                                                   0.29                  0.10

Non-GAAP net loss per share attributable to our common stockholders, basic and diluted

                                $      

(0.10) $ (0.11)

Weighted-average common shares used in GAAP net loss per share computation, basic and diluted

                                      276,068               127,783

Weighted-average common shares used in non-GAAP net loss per share computation, basic and diluted

                                276,068               127,783


Free Cash Flow
We define free cash flow as net cash used in operating activities less cash used
for purchases of property and equipment. We believe that free cash flow is a
useful indicator of liquidity as it measures our ability to generate cash, or
our need to access additional sources of cash, to fund operations and
investments.
Free cash flow has limitations as an analytical tool, and you should not
consider it in isolation or as a substitute for analysis of our results as
reported under GAAP. Some of these limitations are:
•it is not a substitute for net cash used in operating activities;
•other companies may calculate free cash flow or similarly titled non-GAAP
measures differently or may use other measures to evaluate their performance,
all of which could reduce the usefulness of free cash flow as a tool for
comparison; and
•the utility of free cash flow is further limited as it does not reflect our
future contractual commitments and does not represent the total increase or
decrease in our cash balance for any given period.
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The following table presents a reconciliation of free cash flow to net cash used
in operating activities, the most directly comparable measure as determined in
accordance with GAAP, for the periods presented (in thousands):
                                                   Three Months Ended March 

31,

                                                       2021                 

2020

Net cash used in operating activities       $        (88,882)              $ (32,001)
Less:
Purchase of property and equipment                   (11,744)               

(7,566)

Free cash flow                              $       (100,626)              $ (39,567)
Net cash used in investing activities       $        (89,626)              $  (7,891)
Net cash provided by financing activities   $         22,624               

$ 377,042



The year-over-year decrease in free cash flow was primarily due to the payment
of the bonus for our fiscal year ended December 31, 2020, our net loss, higher
payroll taxes on stock-based compensation, prepayments of software licenses, an
increase in working capital as our business grows, and a one-time payment
related to our real estate.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through the net
proceeds we have received from the sales of our convertible preferred stock and
common stock and through payments received from customers using our platform. As
of March 31, 2021, our principal sources of liquidity were cash, cash
equivalents, and marketable securities totaling $1,647.2 million, which were
primarily held for working capital purposes.
Since our inception, we have generated losses from our operations as reflected
in our accumulated deficit of $906.5 million as of March 31, 2021. We expect to
continue to incur operating losses for the foreseeable future due to the
investments we will continue to make in research and development, sales and
marketing, and general and administrative. As a result, we may require
additional capital to execute our strategic initiatives to grow our business.
We believe our existing sources of liquidity will be sufficient to meet our
working capital and capital expenditures for at least the next 12 months. Our
future capital requirements, however, will depend on many factors, including our
growth rate; the timing and extent of spending to support our research and
development efforts; capital expenditures to build out new facilities and
purchase hardware and software; the expansion of sales and marketing activities;
and our continued need to invest in our IT infrastructure to support our growth.
In addition, we may enter into additional strategic partnerships as well as
agreements to acquire or invest in complementary products, teams and
technologies, including intellectual property rights, which could increase our
cash requirements. As a result of these and other factors, we may choose or be
required to seek additional equity or debt financing sooner than we currently
anticipate. If additional financing is required from outside sources, we may not
be able to raise it on terms acceptable to us, or at all. If we are unable to
raise additional capital when required, or if we cannot expand our operations or
otherwise capitalize on our business opportunities because we lack sufficient
capital, our business, results of operations, and financial condition would be
adversely affected.
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Our changes in cash flows were as follows (in thousands):

                                                                     Three 

Months Ended March 31,

                                                                       2021                   2020
Net cash used in operating activities                           $        (88,882)         $  (32,001)
Net cash used in investing activities                                    (89,626)             (7,891)
Net cash provided by financing activities                                 22,624             377,042

Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash

                                               9                 (72)

Net change in cash, cash equivalents, and restricted cash $ (155,875) $ 337,078



Cash Used in Operating Activities
During the three months ended March 31, 2021, net cash used in operating
activities was $88.9 million and was primarily due to the payment of the bonus
for our fiscal year ended December 31, 2020, our net loss, higher payroll taxes
on stock-based compensation, prepayments of software licenses, an increase in
working capital as our business grows, and a one-time payment related to our
real estate . A substantial portion of our accounts receivable balance comes
from advertising partners and is offset by an accounts payable amount due to our
publishers (Operate Solutions customers). However, the payment terms that we
offer our advertising partners are generally shorter than the payment terms with
our publishers (Operate Solutions customers). As such, our cash flows fluctuate
from period to period due to revenue seasonality, timing of billings,
collections, and publisher payments. Historical cash flows are not necessarily
indicative of our results in any future period.
Cash Used in Investing Activities
During the three months ended March 31, 2021, net cash used in investing
activities was $89.6 million, consisting of the purchase of marketable
securities of $129.1 million, cash used in acquisitions of $24.8 million, and
capital expenditures of $11.7 million partially offset by proceeds of $80.0
million from marketable security principal repayments and maturities.
Cash Provided by Financing Activities
During the three months ended March 31, 2021, net cash provided by financing
activities was $22.6 million and consisted solely of proceeds from the exercise
of stock options.
Contractual Obligations
The following table summarizes our contractual obligations as of March 31, 2021
(in thousands):
                                                                            Payments Due by Period
                                                                                                                             More than 5
                                        Total            Less than 1 Year           1-3 Years           3-5 Years               Years
Operating leases (1)                $  155,639          $         22,941          $   74,968          $    16,180          $     41,550
Purchase commitments (2)               128,980                    22,925              90,430               15,625                     -
Total (3)                           $  284,619          $         45,866          $  165,398          $    31,805          $     41,550


(1)  Operating lease obligations consist primarily of obligations for real
estate.
(2)  The substantial majority of our purchase commitments are related to
agreements with our data center hosting providers.
(3)  This table generally excludes amounts related to income tax liabilities for
uncertain tax positions, since we cannot predict with reasonable reliability the
timing of cash settlements to the respective taxing authorities.
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Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements and did not have any
material holdings in variable interest entities as of March 31, 2021.
Critical Accounting Policies and Estimates
Management's discussion and analysis of our financial condition and results of
operations is based on our condensed consolidated financial statements, which
have been prepared in accordance with U.S. GAAP. The preparation of our
condensed consolidated financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported revenue generated and expenses incurred
during the reporting periods. Our estimates are based on our historical
experience and on various other factors that we believe are reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying value of assets and liabilities and the amount of revenue and
expenses that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions, and any
such differences may be material.
There have been no material changes to our critical accounting policies and
estimates during the three months ended March 31, 2021, as compared to those
disclosed in our annual report on Form 10-K for the year ended December 31,
2020, filed with the SEC on March 5, 2021.
Recent Accounting Pronouncements
See Note 2, "Summary of Accounting Pronouncements," of the Notes to Condensed
Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign currency exchange risk
The vast majority of our cash generated from revenue is denominated in U.S.
dollars, with a small amount denominated in foreign currencies. Our expenses are
generally denominated in the currencies of the jurisdictions in which we conduct
our operations. Our results of current and future operations and cash flows are
subject to fluctuations due to changes in foreign currency exchange rates. The
effect of a hypothetical 10% change in foreign currency exchange rates
applicable to our business would not have had a material impact on our
historical consolidated financials. As the impact of foreign currency exchange
rates has not been material to our historical operating results, we have not
entered into derivative or hedging transactions, but we may do so in the future
if our exposure to foreign currency becomes more significant.
Interest rate risk
As of March 31, 2021, we were subject to interest rate risk in connection with
our Credit Agreement. Interest rate changes generally impact the amount of our
interest payments and, therefore, our future net income and cash flows, assuming
other factors held constant. Assuming the amounts outstanding under our Credit
Agreement are fully drawn, a hypothetical 10% change in interest rates would not
have a material impact on our consolidated financials.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended ("Exchange Act"), as of the end of
the period covered by this report.
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In designing and evaluating our disclosure controls and procedures, management
recognizes that any disclosure controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. In addition, the design of disclosure controls and
procedures must reflect the fact that there are resource constraints and that
management is required to apply its judgment in evaluating the benefits of
possible controls and procedures relative to their costs.
Based on management's evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures are
designed to, and are effective to, provide assurance at a reasonable level that
the information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in SEC rules and forms, and that such information is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosures.
(b) Changes in Internal Control Over Financial Reporting
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of any changes in our internal control over financial reporting (as
such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during our most recently completed fiscal quarter. Based on that
evaluation, our principal executive officer and principal financial officer
concluded that there has not been any material change in our internal control
over financial reporting during the quarter covered by this report that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting, despite the fact that the majority of our
employees are continuing to work remotely due to the COVID-19 pandemic. We are
continually monitoring and assessing the COVID-19 situation on our internal
controls to understand the potential impact on their design and operating
effectiveness.
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