Applovin Corp

NASDAQ:APP

Earnings Call Transcript 2023-Q4

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Okay. Everyone please standby. We are about to begin. Welcome, everyone, to AppLovin's Earnings Call for the Fourth Quarter and Year Ended December 31, 2022. I'm Ryan Gee, Head of Investor Relations. And joining me today to discuss our results are Adam Foroughi, our Co-Founder, CEO and Chairperson, and Herald Chen, our President and CFO.

Please note, our SEC filings as well as our shareholder letter discussing our fourth quarter performance are available at investors.applovin.com.

During today's call, we may be making forward-looking statements regarding future events, market expectations or future financial performance of the company and the strategic review of our apps portfolio. These statements are based on our current assumptions and beliefs, and we assume no obligation to update them, except as required by law. Actual results may differ materially from the results predicted. We encourage you to review the risk factors in our most recently filed Form 10-Q for the fiscal quarter ended December 30, 2022, and in our upcoming Form 10-K for the year ended December 31, 2022.

We will also be discussing non-GAAP financial measures. These non-GAAP financial measures are not intended to be a substitute for, or superior to, our GAAP results. Please be sure to review the reconciliations of our GAAP and non-GAAP financial measures in our shareholder letter. This conference call is being recorded, and a replay will be available on our IR website shortly.

I'd now like to turn it over to Adam for some opening remarks, and then we'll open it up for Q&A. Please go ahead, Adam.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Thanks, Ryan. Ryan, are we on video?

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Yes. Please go-ahead guys.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Okay. Thank you. Thanks for joining us today.

Recently, I was reflecting on our first 1.5 years as a public company. Some things are certainly much different from when we were private. A lot more people are fixated on quarterly results than our long-term plan. Every day, there's a scoreboard or a stock price, and of course, we hold these earnings calls every quarter. We did not do that when we were private. But the most important things have not changed one bit.

First and foremost, the most important thing we've got here is our team and culture. Our key team continues to work very closely together to deliver on our products and our vision, and we continue to add great talent to our team while maintaining our entrepreneurial and lean culture.

And second is our motivation. We're all still incredibly hungry today and working harder than ever before because the opportunities we see in front of us are bigger than anything we've ever seen in the past.

The other thing that hasn't changed is the need for relevant advertising. Relevant advertising funds free digital content. As we talk about the economic slowdown and we talk about the IDFA and privacy headwinds, we sometimes lose sight of the fact that relevant advertising helps consumers discover content, and it helps the publisher monetize the content that they've developed that they're giving away for free. If any part of this equation breaks down, you're going to end up having less usage and consumption and less investment into great content, and it's just going to be a tremendous loss for consumers and businesses because of that, we know that our industry is going to be resilient.

So what are the business opportunities that we hear are most focused on today? Number one, over the last several years since we released AXON, the advancements in AI technologies have been incredible. Well, now we're working on AXON 2. We're going to use some of these new technologies for release some point in 2023. We believe this new platform and upgrade to our core technology will make an immense impact on our business and for our business partners.

Second, we're really excited about the Connected TV space. We're actively extending our marketing solutions today to the Connected TV device. This category of advertising is bigger than the one we operate in today, and it's much faster growing. We believe this is going to become a big part of our Software Platform in the coming years and a very fast-growing one.

And third, we continue to invest in innovative products to help carriers and OEMs better monetize their users. We all know that handset device sales have slowed down as mobile market is saturated, and these constituents need better products to be able to monetize their audience with and we're going to deliver those products.

As we've gone public a little over 1.5 years ago, we continue to operate the same way we did private because we know that works. We were incredibly successful for a decade before we went public, focusing on building long-term products and technologies that are innovative that when we release them into the market and have success with, we can create immense value gains for our business, our shareholders and our customers.

With that, I'm going to hand it off to Herald.

[Herald Chen, President and Chief Financial Officer]

Thanks, Adam.

In our last two shareholder letters, we talked about a theme of stability, which is a very nice thing to have in this current market environment. In particular, we have stability with a fantastic team, and we have stability with our business model and financial profile. That affords us the resources and time to invest wisely in our existing and leading products, new initiatives as well as invest for the future. There's a couple of other themes that we wanted to touch on today as well, two of them being simplification and focus, both internally and externally. Internally, we are focused on what we can control and spend a lot of time ensuring that our best resources are allocated to our best returning projects.

An example of that has been our effort to optimize our apps portfolio, which is nearing completion. We spent the last 6 months working on headcount reductions, reformatting, earn-outs, focused on the sale and spin and closure of underperforming assets. And that's really allowed us now to get to a position where we've increased the cash flow, and management time is now focused on delivering value with our remaining portfolio. We're pleased to say we have 11 remaining studios and publishing partners that we're excited to invest to grow and ultimately maximize the value of that portfolio going forward.

One note you'll see in the shareholder letter in our financials that we did is that, we did take a $128 million net loss charge for the divestiture and closure of these assets, including $100 million in the fourth quarter. Another area where we're simplifying and focusing is on the initiatives we have in hand. As Adam mentioned, we've got some amazing projects underway that we're super optimistic about. And that means the bar for our M&A program has gone up. We're certainly still in the market for assets that are attractive to us, but they would need to be highly synergistic, strategic and a great valuation. So the bar is high for M&A.

And lastly, we remain focused on what we've always been focused on when we were private or public, and that's making decisions for the long term. So that while we will give the first quarterly guidance one quarter out, we're very much focused on the long-term and won't manage to near-term targets.

Turning to the financials quickly, and I won't reiterate all the facts and data that's in the shareholder letter, but I will highlight a few key things. First of all, the fourth quarter came in at the high end, both on the top line and bottom-line for where we guided to in the third quarter for the fourth quarter. Included in that was Software Platform performance which grew 24% year-over-year.

For the entire year '22, we came in at $2.8 billion of revenue and generated over $1 billion of EBITDA, and that equates to a 38% margin. Then for the first quarter of this coming year, we're guiding to essentially the quarter being flat to the fourth quarter in total revenue as well as total EBITDA.

One note for the next quarter is we are going to change and simplify some of our KPIs that we're reporting, in particular with regard to the Software Platform side of the equation. We believe several of the metrics that we have been offering are a bit confusing and really are not indicative or helpful to understanding our business. That's because the Software Platform apps, applications and solutions have become much broader. The size of the customers are different as well. So having a singular metric like SPEC and revenue per SPEC aren't terribly helpful. So we'll be taking away those two metrics as well as the TSTV metric going forward.

What we do want to focus you though are on the metrics that are meaningful. And our biggest business in Software Platform is the AppDiscovery business plus ALX. And there's a metric that we've been reporting historically, and we'll report going forward that we do think is important. And that's around our revenue per install and the number of installs. And we will continue to report those metrics going forward.

In '22 over '21, that metric increased 46% in terms of revenue per install for ALX and AppDiscovery and increase in terms of the number of installs by 24%. So we would guide you to make sure you're focused on those metrics going forward. And of course, we will continue to evaluate one of the best metrics to describe our business going forward as other components of our software business grow over time.

In terms of the overall financial performance of our business, we are glad that we had $1 billion of EBITDA and we have now over $1 billion of cash. We are very focused on free cash flow as well. And you'll see in our shareholder letter, we've added a new table where we've given you the 8 trillion quarters of free cash flow performance. We had 260 million of EBITDA in the fourth quarter and 132 million of free cash flow.

Our definition of free cash flow is the free cash flow from operations, less CapEx and less finance leases. So we think that's a great indicator of not just EBITDA, but actual free cash flow to the bottom-line which we're proud of. Our financial position allows us to have this resiliency in our business where we can invest in what we wanted to grow as well as find new investments going forward. And that can range from M&A where there's a high bar, but also share buybacks.

In terms of share buybacks, as you can see in '22, we invested over $340 million against our $750 million authorized buyback. But in the fourth quarter, we did not buy back any shares as we are continuing to assess our capital allocation policy as well as increase the amount of cash in the quarter so that we ended the year with over $1 billion of cash.

We think we're well positioned today and going forward, given the financial wherewithal for our business to invest in the initiatives we are excited about as well as consider other investments, including share repurchases going forward.

So in summary, we're very glad to have the stability that we have in our business as well as the financial wherewithal that we have. We think we've got an amazing team focused on the right things, and we're optimistic about the future ahead.

0And with that, I'll turn it over to Ryan for Q&A.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Yes. Thank you, Herald. So we'll now begin the question-and-answer portion of the call. [Instructions]. Okay. Our first question will come from Vasily Karasyov from Cannonball Research. Vasily please go ahead.

[Vasily Karasyov, Cannonball Research]

Good afternoon. Adam, in your prepared remarks, you mentioned that Connected TV is one of the growth areas. So I think investors and analysts at this point understand Connected TV pretty well to understand what you do. Can you help us connect how exactly you are going to address this market and what function you are hoping to perform there and what kind of revenue opportunities you see maybe in simple terms? I would appreciate it. Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes, for sure. I'll speak to just the product side. We're a performance marketing business at its core. And what we've done really well in mobile over the last decade is enable advertisers to buy advertising, full-screen video ad, high definition and measure all the performance of everything that happens after the fact and be able to buy effectively as arbitrage marketers.

The Connected TV device is really exciting for us because it's a television device, full screen, living room, tons of consumption per day. It's connected to the internet. But today, we're not seeing that much performance advertising happening at large scale on that platform, especially when it comes to mobile app developers. In the last couple of years, we invested in an attribution company that's one of the leaders in trying to bring attribution to Connected TV device. We invested in Wurl, effectively we've talked about a CDN for streamers for very high-profile media companies to bring their content to fast channels. I mean, we've also got our core performance platform that, we think is the leader in mobile marketing. And we're going to take that and use Wurl to bring it to market in Connected TV, and we think it can become a big opportunity.

As far as revenue and numbers, this is still really early days here. We believe it will become a substantial and growing part of our Software Platform over years but we're not ready to talk numbers at this point.

[Vasily Karasyov, Cannonball Research]

So essentially, will you be acting as a DSP in programmatic CTV device but with performance advertising. Is that the right way to think about it?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

I'd think about it as full stack. So the same way in mobile, we're an SSP and a DSP. Wurl today has a very well-performing SSP business. We at AppLovin, our biggest business is our DSP. We'll couple those pieces and have a full stack offering for Connected TV partners.

[Vasily Karasyov, Cannonball Research]

Thank you all.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Okay. Thank you, Vasily. Next, we'll go to Ralph Schackart with William Blair. Ralph, please go ahead.

[Ralph Schackart, William Blair]

Adam, in the prepared remarks, you talked about the upgrade that's coming in sometime in 2023 for AXON 2. And I think you said it could have a significant or immense impact. Maybe just a little bit more color about that? Will that be something that will phase in over time? Will it be more sort of abrupt in nature, meaning you potentially have a bigger impact in the near term? Just love a little bit more color on that, please?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. I mean, look, we released AXON 1, I guess, it was around 3 years ago, started working on it 4 years ago. Business grew a ton since we did it. I think we 10x-ed over the period of time from AXON 1 to today. It did build over time. I mean, that's how these technologies work. In the period of time since we built that first technology, obviously, we all know there's been huge advancements in AI technologies and we're working on bringing those to our core platform. The rollout and potential growth from it is just building more efficiency into our system, which will benefit our advertisers. They should be able to hit their goals at larger scale, creating more growth for them and in the category, and, obviously, will benefit us. We don't yet know if it's going to be a step function and continue to build over time, but we do believe that will be how it will look.

[Ralph Schackart, William Blair]

Great. And just one more on the macro, if I could, please. In the letter, you talked about Q4 being soft but stable with Q3, and then Q1 being relatively stable. Maybe just kind of talk about the linearity there. Has it been, I guess, sort of stable over that period? Is it improving? Just any more color you could add on the macro, that would be great. Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

And so in our business, what was directly tied to our revenue, the biggest part of our revenue is performance marketing. And in particular, the largest part of our segment is game advertisers. Game advertisers, our performance marketers, they're buying on some sort of return curve. They have an LTV to CAC model that works in today's market. That's a lot more conservative than it was 1.5 years ago when interest rates were near zero.

As cost of capital went up last year, advertisers got conservative in performance because you just can't afford as long a payback as before. But those values were reset with an expectation of interest rates getting to sort of today's levels. And that was done a couple of quarters ago. So what we've seen in our business might be disconnected from what we talk about in the macro economy as a whole. But in the performance marketing sector, the advertisers got conservative but they're not getting any more conservative because we're not seeing material changes in the economy today versus a couple of quarters ago. And so we've seen a lot of stability in our business and continue to do so.

[Ralph Schackart, William Blair]

Okay. Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thanks, Ralph. We'll next go to David Karnovsky with JPMorgan. David please go ahead.

[David Karnovsky, JPMorgan]

Hey. Thank you. Adam, I guess the logical question after that last comment would be kind of what breaks developers out of that conservative mentality? Is that kind of macro based? And then a separate question, Herald, just regarding your apps portfolio, any update on what you think is the right margin for that to run at going forward? And as you listed the sale of assets in the future as a possibility. I'm curious to know if you had any expressions of interest from strategic or financial buyers at any point? Thanks.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. So on the first question, the reality is performance marketing advertisers have an approach. They have an LTV to CAC and they have their own products. So if their products improve, they can spend more. If interest rates go down, they can spend more. But what's more in our control and what's going to drive this for our business and our partners are our efficiency gains in our core technologies. And that's what I'm talking about with AXON 2.

As we all know that these core technologies, these AI-based implementations of technology are continuing to evolve. As they get more efficient, what ends up happening is advertisers have the same goal, but you can drive them more scale. They start growing their business. They're reinvesting more and more into it. It's all arbitrage marketing on the front end.

And on the back end, the algorithm continues to perform better as the technologies evolve over time. That's a trend we've seen over the last decade. It's accelerating now and it's something that we are very excited about as we look out into our business into the future.

[Herald Chen, President and Chief Financial Officer]

David, thanks for the question. So on the apps side, as we mentioned, we've been in the process of optimizing that portfolio. And we do think in the first half of this coming year or this year, that we'll start to [indiscernible] in terms of the trough of revenue. And the margin has gone up, as you've noted. I'd say from there then, it really depends on our opportunity to grow the assets. So we're excited that of the 11 studios, I think all of them have opportunities for growth. Many of them have some new games that they're thinking about launching this year. And so if we have a hit, we'll invest in dollars there, and we'll bring down the margin. Right now, we're obviously in the very high teens. And that could go back to the low teens, something in that range. If we're investing in new games, it really depends on how robust that return is on those dollars.

So I'd say expect the revenue side to still come down a bit in the near term, but eventually, we'll reach a steady state and then we think about how to grow the business from there. But I would say longer run rate is probably a mid-teens type of margin for that business. And then --

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Go ahead.

[Herald Chen, President and Chief Financial Officer]

Yes. And just on the M&A side, look, we would take an offer if it was the right price for these assets. But as we said, we've now winded it down to these 11 studios that we really like. We're excited to work with them. The market is obviously difficult given cost of capital out there. And so we're going to manage these things as if we own them forever. And if people do show up at the right price, we'll look to optimize the portfolio as we said we would along the way.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. The only thing I have to add, too, is we've removed the distraction of weaker-performing studios. We're now really proud of the studios that we have. The leaders of these studios are exceptional talent. They've got great teams underneath them. The pipelines are really strong at these studios. We do look at this business unit now is something that we're excited about going forward.

[David Karnovsky, JPMorgan]

Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, David. We'll next go to Clark Lampen with BTIG. Clark, please go ahead.

[Clark Lampen, BTIG]

Thanks guys. I had a question maybe first on competitive dynamics across maybe both the sort of gaming but also broader ad market in light of, I guess, more recently sort of peer mergers, but also some of your peers talking about making progress closing the targeting gap relative to sort of pre-IDFA levels. Has that had an impact or has that showed up in sort of developer conversations?

And then maybe a follow-up on the AXON update. Are you in a beta stage right now where there are clients actually sort of testing this product for you? Or could we use the baseball analogy to maybe think about how close we are or what sort of progress you maybe have made, I guess, against the formal launch versus last quarter? Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Thanks, Clark. I'll start with the second one first.

We're not ready to talk about timing. We do expect it to go full scale in '23, and obviously, we always have products to come to market at large scale faster. This product is super complex. We're really excited about the prospects. It does take time to develop, and we first started talking about it a few quarters ago. All we can tell you today is, we think, it's going to make an impact in '23. And it's also not a rollout to customers. It's effectively taking the old engine and upgrading it. So it will impact the whole business once when it does go to full scale.

On the first question, competition in the ecosystem with M&A or ad algorithms improving. We've been in an advertising sector for 12 years now. I've been doing this for nearly 20 years. Advertising is immensely competitive. There's a lot of players that are trying to get ad dollars from advertisers and trying to build algorithms to help those advertisers market themselves. There's never been a shortage of competition.

Now what we do know about our sector is that if algorithms improve, if targeting can get back to pre-IDFA levels, the category was growing almost double digits every single year consistently for a decade. The IDFA change impaired that growth prospect. So all of us marketing companies are really in the business of improving our algorithms. And when together, the category gets to a point where it was before, the category itself will get back to growth. We sit at a leadership point in the category with a market-leading monetization solution and a market-leading growth platform with AppDiscovery. So we'll stand to benefit greatly if that does happen in the marketplace.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Clark, do you have a follow up?

[Clark Lampen, BTIG]

All set. Thank you, guys.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Okay. Thanks, Clark. We'll next go to Bernie McTernan with Needham. Bernie, please go ahead.

[Bernie McTernan, Needham]

Great. Thank you very much for taking the questions. Two for me. First, just a broad questions Adam, like, any thoughts on DOJ suing Google what that means for AppLovin? And then for Herald, anything special about the $1 billion in cash? Just wanted to follow up on the comments and no buyback in the quarter, if that kind of $1 billion cash balance is what a minimum you want to maintain on the balance sheet? Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Well, look, all we can do is speak about our experience with Google. We're a large cloud customer. They launched their bidding solution onto our platform. I think it was our first large-scale external implementation of bidding. They obviously help monetize -- publish our inventory with better advertisements than any company we've ever seen before. So with us, we're great partners, and we look forward to expanding that partnership into the future.

[Herald Chen, President and Chief Financial Officer]

Yes. Thanks for the question. With regard to the $1 billion and the buyback, there's nothing magical about $1 billion. This is a lot of money, and we're glad to have it on our balance sheet. But the reality is, we're bullish on our business as we talked about. We need to be patient. We think we're going to be stable for the short-term here. And so we want to be careful with the cash balance and think about our capital allocation.

And then, the fourth quarter as well as the third quarter, we had different projects going on. The market was changing, the financial market was also, the cost of capital was changing. But we feel really good where we are today. We think having over $1 billion of capital on the balance sheet does help. We are generating a lot of free cash flow as we highlighted. We think that will continue in the first quarter. And we are investing in all the projects internally as we can. So we will, again, as we always do with our Board, think carefully about capital allocation, and we still think our stock is a great place to put money to work.

[Bernie McTernan, Needham]

Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thanks, Bernie. We'll next go to Matt Cost with Morgan Stanley. Matt, please go ahead.

[Matt Cost, Morgan Stanley]

Hi, everybody. Thanks for taking the questions. There's a perception based on some of those third-party data out there about in-app purchase behavior at the level of the mobile games market that maybe things are bottoming out exiting '22 into '23. I guess you're pretty well-positioned to assess, both from your view into the market and from your own games whether or not that might be true. But maybe more importantly, whether or not the rate of change of consumer spending is bottoming out. When that does ultimately turn, like we've been through a year to really weak spending. When it turns around, is that something you expect to flow through to the in-app advertising market pretty quickly? Or is there likely to be more of a lag there? And then I have a follow-up. Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

So we think what drove the growth in-app purchasing over the last decade had a lot more to do with the marketing technologies and targeting than it did with the economy. Consumers need to discover content that they love to be able to go spend in it. And the IDFA change really handicapped the category and it happened abruptly. Now it's been 1.5 years, technologies are starting to adapt. We just saw this in some other earnings reports. You've seen the stability in our earnings reports. All of us marketing companies are working on improving our algorithms to be built around what today's era of privacy allows you to do. It takes time to do that.

The game developers themselves also are working to create content that's different than what they would have built 1.5 years ago. Whale hunting, which is an industry term, but marketing to go buy whales for games they can monetize consumers at immense levels is just not something that's possible anymore in today's identity-free universe. And so game developers have had to go figure out how to make more casual games. That's also a cycle.

The other thing that isn't widely known is that a lot of the top grossing games in the in-app purchasing category come from developed in China. When these Chinese development teams have been highly inefficient in a zero-COVID state, and that's just reversed out. So you're going to get back to more efficiency.

So we think there's a lot of reasons why we're seeing stability. And we think there's also growth that will come in the future. We don't know exactly when, as the marketing platforms improve and as the game developers adapt to this new era.

[Matt Cost, Morgan Stanley]

Great. Thank you. And then, using the new disclosure, if I read it correctly, I think that pricing grew at almost double the rate of volume in the quarter. So I'm just wondering, is that sort of a recovery off of a period of lower auction and bid density? Is that the way you should think of what happened in the quarter? And then are you expecting pricing to be a stronger driver than volume over the course of the coming quarter and year as things hopefully recover?

[Herald Chen, President and Chief Financial Officer]

Yes. Thanks, Matt. Just one correction for you. It wasn't the quarterly metrics there. It's actually the annual metrics from '22 over '21, I guess, the revenue per install was twice the rate of the actual installs. And that really has to do a lot with the efficacy of AXON and then the increase in the volume, both from our network side as well as our ability to bring on more publishers. So it was really the combination with the two of them. And those are metrics that we did report in our public financials historically and we'll continue to talk about those going forward.

[Matt Cost, Morgan Stanley]

Okay. Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Okay. Thank you, Matt. We'll take the next question from Franco Granda with D.A. Davidson. Franco, please go ahead.

[Franco Granda, D.A. Davidson]

Yes. Good afternoon, everyone. Two for me today. So entering last year, you had talked about the expectation to have $10 billion transacted through your platform. Last quarter, you obviously stopped talking about it due to macro but what was the actual number for '22? And then, what was the run rate number exiting the fourth quarter?

And then, for the second question, what is the magnitude of investments for the AXON 2 upgrade?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

So I think the first question, you're talking about our maximization platform, how many dollars are flowing through it. We're not disclosing exact. The MAX platform, though, has a ton of reach in the industry. We actually recently asked our team to pull top apps in both app stores to see how much usage of our platform there was for the rest of the market. And about 2/3rds of those apps, top downloaded apps are monetizing using your MAX solution. So in terms of usage, there's been exactly what we expected with that platform, market leading.

What's changed versus the beginning of last year and today or end of the year are CPMs, in particular from brands. As the economy became more difficult throughout the year, the dollars and the density in the ad auction, which is monetized by many companies more than us, has decayed. So that would be what threw us off of our projection. But the daily active users and the trends to MAX usage are exactly where we thought they'd be. They're performing very well.

On the magnitude of the AXON investment, that's all built into our P&L. Our R&D investments, in line with what I mentioned on my talk track around our culture, are always going to be lean. We've got a core group of talent on our engineering team and we're adding really exceptional people to that team. But we're adding them in the tens, not hundreds or thousands, so you don't see a dramatic R&D expense line in our business yet, we do invest heavily into new products that can make a big impact.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, Franco. We'll next go to Eric Sheridan with Goldman Sachs. Eric, please go ahead.

[Eric Sheridan, Goldman Sachs]

Can you hear me? Sorry, just took me a second to unmute there. Maybe two, if I can. One sort of bigger picture question that maybe is a little bit outside the box. Obviously, you talked earlier in the call about Connected TV. How do you think about taking the data engine you've built? And I know, obviously, the central dynamic is still around mobile gaming. But how do you think about taking the data engine and the platform and thinking about a wider array of canvases and possibly a wider array of SKU and industry verticals from the advertiser side, either through your own organic efforts and maybe through partnership around the broader advertising landscape, that would be number one.

And you talked a lot on the call about how we've gotten sort of back to a level of stability, but probably not full return from a demand perspective on the advertising side. Is the way to frame up the element of how much of your margin structure is somewhat held back or depressed by a lack of return to sort of pre-IDFA or pre-pandemic normalization levels? And in which case, a full recovery could possibly be an extra layer of tailwind to the incremental margin structure? Thanks.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Thanks, Eric. I'll answer the first one. Herald will take the second.

On the first one, to answer the question simply, we're super excited about the potential to extend our marketing engine and the algorithms to other platforms. So CTV, obviously, being the first. And there's nothing that restricts us to the games category. Games is, obviously, the largest part of our AppDiscovery solution. But really the limitation, so far, has been that our advertisements almost always show up in the games. And if you're doing a contextual and behavioral advertisement that signal is very strong to match up a game advertiser and a game publisher. While Connected TV offers a completely different landscape for us, we believe what's missing from that platform is performance marketing and we can do that well. But our engine, our data is not limited to just gaming. So we think the Connected TV screen is going to allow us not only to extend game advertising to that television device but also to bring other advertising for other companies.

Wurl, for instance, works very closely with a lot of high-profile streaming businesses. And advertising on a performance basis for those is a huge initiative and big opportunity. And we think as we talk about our Connected TV to business in a couple of years, we're going to be talking about a wide breadth of advertiser types.

[Herald Chen, President and Chief Financial Officer]

The margin side for our business, we're at a steady state and stable as we talked about. But we are excited by the fact that if we can lift, for example, our biggest business, in particular, on the AppDiscovery side with an AXON 2.0 implementation at some point, those are very high-margin dollars to flow to the bottom line, and that would be a pretty meaningful increase in EBITDA for the segment and EBITDA for the overall business. What does offset that is there is infrastructure costs that do increase, but, obviously, at a much slower rate potentially. And then we do have an incremental headcount that we're hiring.

As Adam said, more in the 10s and 20s, not hundreds, to go after some of these new initiatives that are pretty big, whether it be CTV or endeavor into a business called Array, which is focused on the OEM carrier space. So that could bring down margins to some degree. But we're comfortable with the margins we run out today and we think it's more incremental on the upside, in particular, for our biggest business to the extent we can get that to grow.

[Eric Sheridan, Goldman Sachs]

Great. Thanks so much.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, Eric. We'll next go to Omar Dessouky with Bank of America. Omar, please go ahead.

[Omar Dessouky, Bank of America]

Hi. Thank you for taking my question. One of the large hyper-casual publishers that reported earlier this week appeared to be implying that they would be reducing advertising spend. And I was wondering, number one, how consequential is the hyper-casual market to your ad platform? And number two, are you seeing that as a kind of trend in the fourth quarter and potentially going forward? And then I have a follow-up on hyper-casual.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. So we've got a lot of density of advertisers. No single category makes up a huge part of our business. And as you saw in our numbers in Q4, our numbers were really stable. And in Q1, we're guiding to similar numbers to Q4, both for top-line and bottom-line, implying that our software business is really healthy right now. So yes, certain categories, especially those that are dependent on ads, might perform worse. On the flip side, when you have a super dense auction and you work with tons of advertisers across a lot of different genres and you've got a good targeting engine that doesn't create exposure for you and your business.

[Omar Dessouky, Bank of America]

Great. Thanks. And then, the follow-up question is that, according to industry experts, Google has begun sending rejection notices for ad exposures and formats that are not compliant with its new Better Ads Experiences policy. This policy disallows interruptive interstitial ads among other practices. And I was wondering whether this is something the industry is over already or is it something that -- is the solution to this problem within AppLovin's technology stack or is it at the kind of studio level? And again, -- have you seen any of the effects of this policy on hyper-casual?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. We actually don't expect any effects from the policy. We didn't see any early on. We don't expect any going forward because the best apps, the ones with a lot of users, they don't tend to show ads out of place. The policy itself was explicitly written to prevent a publisher from showing an ad when a user expected something else.

So for example, you go click a Play the Game button and you get a pop-up ad. That's disruptive, and Google doesn't want that. Well, the highest quality publishers and the ones that are at scale that we work with or know personally, our bigger customers, they can never run ads like that because users usually churn out of those games. So it's certainly a policy to clean up the app store. But the Google Play App Store has millions of apps in it. The ones that are large-scale apps never engage in those types of practices.

[Omar Dessouky, Bank of America]

Excellent. Super helpful. Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, Omar. We'll next go to Stephen Ju with Credit Suisse. Stephen, please go ahead.

[Stephen Ju, Credit Suisse]

Okay. Thank you. So I guess you spent a lot of time talking about potentially expanded opportunities. And I think in the past, we've talked about the advertising opportunity outside the games vertical. And I get that this is probably a tough market to go after new business. But I was wondering if you can comment on where you may be seeing greater traction because I would love to see the games as a percentage of ad revenue de-index over time and other performance-oriented budgets starting to flow into AppLovin. Thanks.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes. Thanks, Stephen. We're looking at expansion there on the Connected TV screen and also with the carrier OEM product. Both of these are advertisements into placement without context. But when you're selling an advertisement in a game app, it's really hard to suggest that you could go, especially as the Wurl goes to more contextual with some data in order to drive relevant advertisement, but with more of a contextual signal, it's really hard to suggest that it's a good strategy to go outside the gaming sector in that publisher set.

We do believe that these other categories of advertising will become very big businesses for us over time. And we also have a gateway into that category with that just team and all of the non-gaming advertisers they work with. If you recall, when we first did that transaction, we talked about the majority of their 4,000-plus customers are non-gaming customers. And these are the types of customers that are really excited about our Connected TV offering.

[Stephen Ju, Credit Suisse]

Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Okay. Thanks, Stephen. We'll take our next question from Martin Yang with Oppenheimer. Martin, please go ahead.

[Martin Yang, Oppenheimer]

Hi. Good afternoon. Thank you for taking my question. Can you hear me?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes, we got you, Martin.

[Martin Yang, Oppenheimer]

Sorry. Thanks. So my first question is on new games release environment. You talked about potential growth opportunity from the 11 studios where there new games. Can you maybe comment on how does new game release environment change over time versus pre-pandemic or pre-IDFA? And is there any signals that give you confidence that those new games can test well and then release on the market as you expected?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Well, look, with the changes in marketing, the bar has gone way up for new games. Traditionally, you can create iterations of working concepts in the market. Now developers have to be a lot more innovative to get a new game to grow. And our studios have made the same shift. The ones that we've retained have really strong development teams and are working on games that the ones that are in soft launch will get tested longer now. We'll make sure that the data looks strong before we release it to market, that it will be something that we're confident in.

And the ones that are developing are no longer developing the way they would have 1.5 years ago. They're developing in a new format. And we think this is where the whole market is going to go, you're going to take longer-term bets that are more innovative. There might be less likelihood of success to new games, so you don't expect one out of every two games to hit, maybe it's one out of every four or five. But by creating innovative new concepts, it can expand the market over time. And so that's where we're investing, and we think we have the teams to do that well.

[Martin Yang, Oppenheimer]

Got it. A follow-up question on games is, can you maybe comment broadly on what genres do you see a higher success rate in this market? And what type of business model within the games? Is it hybrid in-game purchase plus advertising? Advertising only? or in-game purchase?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Yes, we think it's the requirements --

[Martin Yang, Oppenheimer]

All those two vectors?

[Adam Foroughi, Chief Executive Officer and Co-Founder]

We think it's a requirement now for developers to make hybrid, just as you said. If you can't go and market to the whales. Well, you've got to monetize the whole audience. And traditionally, the IAP category, 95% of the users were unmonetized, 5% were whales. They funded this $100 billion in growing space. Now you can't go find those users as successfully as before. So you've got to monetize the 95% to subsidize the cost of acquiring the 5%. And that's actually really good for us in our MAX business and our AppDiscovery business because it brings more inventory online, and we're starting to see some of those trends.

[Martin Yang, Oppenheimer]

Thank you.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, Martin. We'll take our last question from Mark Zgutowicz with Benchmark. Mark, go ahead please. Martin, please check that you've unmuted your equipment.

[Mark Zgutowicz, Benchmark]

Oh, sorry. Thanks, guys. If we look at your software platform clients and the revenue for that client over the last four quarters, it's consistently been down sequentially. And I'm just wondering what is the sort of the driver of that trend line? And sort of why that is not, I guess, consequential to your results going forward anymore? Thank you.

[Adam Foroughi, Chief Executive Officer and Co-Founder]

Sorry, Mark, I'm not sure which metrics you're referring to. Our SPEC metric went up from Q3 to Q4 from 532 accounts to 566 accounts. So the trend --

[Mark Zgutowicz, Benchmark]

Look at just quarter-over-quarter growth, just declining sequentially over the last quarters for both of those --

[Herald Chen, President and Chief Financial Officer]

You're talking about pricing, right? It's just the composition is hugely different than it was before because we've added on Wurl. We've added on Adjust. We added on ALX, MoPub. So the composition has changed so much that those metrics aren't very comparable anymore to the past, and they're not very predictive of the business going forward and that's why we decided this quarter to remove them.

[Mark Zgutowicz, Benchmark]

Okay. What about the Software Platform enterprise client itself, that number? How important is growth in that number going forward in terms of your Software Platform revenue?

[Herald Chen, President and Chief Financial Officer]

Yes. Again, Mark, that number has gone up. And the actual average revenue per software client has remained steady around $1.9 million. And also the net dollar retention went up over 160%. But this is exactly the reason why we're going to remove these metrics from our reporting because they're not indicative nor to give you a better sense for how the software business is performing, which is obviously flat, essentially flat from Q3 to Q4.

But as Adam said, we're excited and optimistic about the platform. We think the market is reasonably stable. We're investing a lot to improve our market-leading tools in the category. So as we're able to launch new capabilities and hopefully, the market returns to growth. We should be in a good spot for both top-line and bottom-line growth in that segment.

[Mark Zgutowicz, Benchmark]

Okay. Thanks, guys. Appreciate it.

[Ryan Gee, Head of Investor Relations and Strategic Finance]

Thank you, Mark. And that does conclude the question-and-answer session for this quarter. We thank you all for joining us today. Have a good afternoon. Thanks, everyone.