Earnings Call Transcript - U Q3 2024

Daniel Amir, VP and Head of Investor Relations

Welcome to Unity's Third Quarter 2024 Earnings Call. My name is Daniel Amir, VP and Head of Investor Relations. After the closing of the market today, we issued our shareholder letter. That material is now available on our website at investors.unity.com. Today, I'm joined by Matt Bromberg, our CEO; and by Mark Barrysmith, our Interim CFO. But before we begin, I want to note that today's discussion contains forward-looking statements including statements about goals, business outlook, industry trends, market opportunities, expectations for future financial performance and similar items, all of which are subject to risks, uncertainties and assumptions. And you can find more information about these risks and uncertainties in the Risk Factors section of our filings at sec.gov. Actual results may differ, and we take no obligation to revise or update any forward-looking statements. Finally, during today's meeting, we will discuss non-GAAP financial measures. These non-GAAP financial measures are in addition to and not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A full recitation of GAAP to non-GAAP is available in our shareholder letter and on the sec.gov website.

Matt Bromberg, CEO

Thank you, Daniel. Good afternoon to everyone. On behalf of all the good folks at Unity from around the world, I'd like to thank you very much for joining today's call. When we were together last quarter, we declared an intention to make meaningful change at Unity. We said we wanted to prioritize execution and discipline to drive more rapid product innovation and to restore the strong authentic bond we have with our customers and our community. We've acted on those intentions over the course of the last 90 days in many different ways, and we're feeling the impact of that positive momentum, both inside and outside the company. We started off with the cancellation of the run-time fee or reversion to a subscription-based model in introducing price increases that customers could understand. And all this has unblocked our renewals pipeline and reconnected us with our community. We followed that up with the delivery of Unity 6, the best-performing, most capable version of Unity we've ever shipped. Unity 6 marks a fundamental change in how we're going to approach the development cycle going forward. At launch, we introduced a new upgrade philosophy, which through greatly enhanced testing and real production environments is designed to enable customers to take advantage of new features over time with fewer sacrifices to stability. Maintaining a better and more consistent feedback loop will help ensure we deliver tools that make a tangible difference for our customers every day. This combination of a new approach, new pricing, and new software is core to our strategy. When developers choose Unity, they're potentially building a business on top of our platform for decades, and we're dedicated to making that choice work for them. We're also receiving positive momentum outside of our gaming customer set. Growth has remained strong in the industry during Q3 and remains our fastest-growing subscription business. Key new customer accounts this quarter included KLM, the Dutch Airline, who are building a VR cockpit training application, and Deutsche Bahn, the German national rail operator, who built a series of systems and training simulations in Unity. We also talked last quarter about how we're undertaking a fundamental rebuild of our machine learning stack and data infrastructure and using AI to enhance the return on investment we're able to deliver to our advertising customers. We're happy to report great progress on that work, which is already in testing on live data. And we're really encouraged by the early results we're seeing. Game monetization will not be a winner-take-all market. I can tell you for certain from personal experience that customers don't desire that outcome. Unity has a unique insight into how to maximize the lifetime value of the gaming consumer and survive from our intervals in both the development and live operations of cross-platform games. The work we're doing to unlock those insights and to improve the gaming industry for developers and consumers alike motivates us here at Unity every day. We've also made major strides during the quarter in building out a new leadership team. Attracting leaders with depth of experience to make meaningful positive change is critically important to continue growth over the long term. At the end of October, we brought on board Steve Collins as our new CTO. Steve brings decades of experience from his tenure as the CTO at King, the studio behind hits like Candy Crush, as well as being the Co-Founder and CTO of Havok, the pioneering physics engine that helped define modern gaming. Today, we're equally excited to announce that we've hired a new CFO, Jared Gas, who begins full time with us on January 1, 2025. Jared joins Unity from Shutterstock where he has served as CFO for the past five years, helping drive the company's portfolio expansion on data monetization and digital advertising while also emphasizing revenue growth and profitability. In summary, we're pleased to be progressing against our transformation strategy while delivering quarterly results that exceeded the top end of our guidance range. Our vision for Unity is clear. We believe we have a critical role to play in helping to drive the game industry forward to its next stage of growth. We're the only company in the world capable of providing a platform to power the entire development cycle from prototyping through live service management to user acquisition and monetization. This puts us in a position to be able to drive fundamental improvements to the economic calculus of making successful games. On the production side, AI-enhanced tools will speed up the development process and enable greater innovation. While in live operations, advertising and monetization, we'll be able to provide insights that customers won't be able to get anywhere else. We see every one of the 3 billion monthly downloads of a made-with-Unity product as another opportunity to provide value back to the users who are enjoying the product and to our customers who are creating that product. We'll have much more to say about all this as the work continues. Our team is aligned and energized to fulfill this vision while also focused really hard on continuing to improve our business every day. I'll turn the call over now to our Interim CFO, Mark Barrysmith, for an overview of our financial performance. Before I do, I'd like to thank him very much for his work over the last 90 days or so as we prepare to welcome our new CFO to Unity in the new year. Mark?

Mark Barrysmith, Interim CFO

Thanks, Matt. We are pleased with our third quarter results that exceeded guidance for both revenue and adjusted EBITDA. In Q3, revenue from our strategic portfolio was $429 million, down 2% year-over-year and up 1% sequentially from Q2. This compares favorably to our guidance of $415 million to $420 million. Third quarter Create Solutions revenue from our strategic portfolio was $132 million, up 5% year-over-year and up 2% quarter-over-quarter, driven by growth in our subscription revenue, which was up 12% year-over-year. Growth Solutions revenue from our strategic portfolio in the third quarter was $298 million, down 5% year-over-year and up 1% quarter-over-quarter, expanding on the sequential growth we saw in Q2. Adjusted EBITDA for the total company for the third quarter was $92 million, compared to guidance of $75 million to $80 million. We delivered $115 million in free cash flow in the third quarter, up 11% from $104 million in the prior year. Cash and cash equivalents at the end of the quarter were $1.4 billion. With that, let me turn to guidance. We are raising guidance for the full year for our strategic portfolio to $1.73 billion to $1.78 billion, compared to $1.68 billion to $1.69 billion previously. And adjusted EBITDA of $363 million to $368 million compared to $340 million to $350 million previously. This translates to Q4 guidance of $122 million to $127 million and Q4 adjusted EBITDA of $79 million to $84 million for the total company. The Q4 guidance reflects continued caution on the timing of the revenue recovery in our growth business as well as expectations of some additional compute costs associated with training our new AI systems. With that, let me turn the call to Daniel so that we may take your questions.

Daniel Amir, VP and Head of Investor Relations

Thank you. So with that, we'll open up to your questions. If you're interested in asking questions, please click on the raise hand button at the bottom of your screen. At that point, we will allow you to unmute your microphones. Okay. So the first question comes from Jason Bazinet from Citi.

Jason Bazinet, Analyst

Great. Thanks so much. You all have done an excellent job of stabilizing everything, identifying your strategic priorities, and bringing in new talent. For investors looking at this for the long term, what kind of expectations would you set regarding the potential growth of the business over the next three to five years?

Matt Bromberg, CEO

Hey, Jason, thanks for your question. We are really bullish on the long-term value of Unity. We think we are in a really unique spot in a really big, vibrant business. The creation of 3D content in interactive entertainment is just going to grow. We believe that we are in an amazing spot as a tools provider to fundamentally change how the next generation of content gets created. Again, I can tell you, as someone who made games for a really long time, when you think about starting new projects and how much you can invest, that calculation is a direct result of how many people and how much time. As a tools provider and a proud tools provider and as a platform provider, we have an opportunity to fundamentally change how people think about creating interactive content. If they can do it more efficiently and effectively, they're going to make more and they're going to innovate more, and we're going to get growth. And we're really excited and proud to play that role. As I said again, in the opening statements, we think we are in a unique spot with respect to being the only company, and we believe in the world, that can sit as a platform through the entire life cycle of development from prototyping through to operating live service and into monetization and advertising in the U.S. And those insights that we glean from being a platform, we can share those with our customers and fundamentally offer insights that we think over time that no one else can. To your point, we've got work to do, but we know what the work is, and it's work doable, and we're excited about it, and we're seeing and feeling the wind at our back from the perspective of how customers are responding and some of the early results of the investments we're making. This is a business that we really couldn't be more excited to be in.

Jason Bazinet, Analyst

I don't want to put words in your mouth, but is it fair to say that the algorithm is you believe you can grow faster than whatever the mobile gaming industry is growing, given the value that you're providing plus using your software and non-gaming verticals on the Create side?

Matt Bromberg, CEO

I would say that there is, I guess, the way I would say is there's a lot of runway for us to grow in this market, especially on the user acquisition monetization side. We're convinced that as our offering and our tools and our insights improve, the opportunity is going to be meaningful.

Daniel Amir, VP and Head of Investor Relations

Thank you, Jason. So the next question is from Clark Lampen at BTIG.

Clark Lampen, Analyst

Thanks very much. Can you guys hear me, okay?

Daniel Amir, VP and Head of Investor Relations

We can.

Clark Lampen, Analyst

Matt, I wanted to follow up on the growth topic we discussed earlier. You mentioned that you're currently in live testing. Can you help us understand what the roadmap for launch and development looks like? Additionally, can you provide context on what you're seeing regarding campaign performance and efficacy?

Matt Bromberg, CEO

Yes. I mean I can describe for you the process of sort of building, testing, and validating a platform of this nature. It's one that probably won't surprise you to learn is highly iterative. What I was making reference to in the opening about testing a lot of data, we've got kind of our new machine learning models and our new neural network. It's up, and we're testing it on live data. Obviously, what you want to see is you want your new models to be better than your old models, and you want those new models to be meaningfully better in all different weathers in different genres, in different geographies, in different market conditions. It takes time to validate that work. In the interim, you're effectively operating two networks. The roadmap looks like us continuing to build out that capability, continuing to validate and continue to test and launching when it's ready. I don't want to get too far out in front of the work and be overly specific on that. But again, I would say that we're feeling very good about where we are and the impact we hope it will have.

Clark Lampen, Analyst

Understood. At the top of the call, you sort of talked about exact change; you've certainly wasted no time on that front. The run-time transition. I'm curious, I guess, I think a lot of folks, myself included, have been really focused on the numbers' impact of introducing variable fees, and less so, I think, the relationship consequences for you and some of the publishers that are using the platform. If we were to pull back and think about how that's improving, what sort of opportunities with sort of enhancement or expansion of the existing relationships exist or maybe will be sort of front and center for you guys in '25? Thank you.

Matt Bromberg, CEO

Thank you for the follow-up. The manner in which we eliminated the run-time fee was as significant as the repeal itself. Our relationships with customers and our goal of partnering with them is vital, as many will remain customers for decades. Expanding these relationships on both the platform and advertising sides is essential, so we need to prioritize them. In the past, we lost sight of the human element in pricing and relied too much on abstract concepts. It's important for customers to feel satisfied and aligned with the value being provided and how they are billed, as this is crucial for long-term relationships. Engaging with customers before the changes and seeking their feedback was vital in redefining our approach in the market. We have a strong outlook for expanding these relationships over time. Selling consumption-based products, such as multiplayer tools, live operations services, and AI-enhanced tools, is a natural result of platform adoption and customer relationships. It's also important to think differently about product development. Previously, we created many products without validating them in real-world settings. We need to collaborate with customers to design tools that meet their needs, allowing us to then sell those solutions to more customers. Expanding relationships over time and getting pricing right is critical for us. We're optimistic about our pricing setup and the growth potential for our customers without any complications, allowing for more consistency going forward.

Daniel Amir, VP and Head of Investor Relations

Great. Thank you, Clark. So the next question is Brent Thill from Jefferies.

Brent Thill, Analyst

Great. Matt, regarding the changes you've made to your team and the new hire, how far along are you in the process of assembling the right team to execute your plans going forward?

Matt Bromberg, CEO

Yes. Thank you so much for the question. We feel really good about where we are in that respect. We're really good with the construction of the team. Lots of great experience, lots of operational focus, and lots of really specific understanding in the markets that we're operating in. Just really connected with one another in terms of the vision and being aligned around changing the culture and executing and delivering value to customers. I'd say that we're pleased with the pace of that change, with our ability to attract the right talent. Much of the talent has come from within our organization. Yes, we've had some key external hires in the CFO and CTO that we talked about today. There's a very strong bench of incredibly smart and effective people at Unity that we've been able to elevate, who provide us not only the ability to make change and progress but also a deep understanding of the history of the company. So I’m feeling we're in a pretty good spot. You're always looking to bring world-class talent in when you can, but we're pleased with the progress and where we are in that process.

Daniel Amir, VP and Head of Investor Relations

Great. Thank you. Next question is Gili from Goldman Sachs.

Gili Naftalovich, Analyst

Hi, everyone. Thanks for taking the question. Confirming you can hear me, okay?

Daniel Amir, VP and Head of Investor Relations

Yes.

Matt Bromberg, CEO

Yes.

Gili Naftalovich, Analyst

Okay. Perfect. Nice to talk to you guys. I'm curious, Matt, as you talked this quarter, how is the insulation of the run-time fee and the official launch of Unity 6 changed the perception or willingness of customers to adopt the new game engine? Curious to know how maybe key metrics you are evaluating such as new game starts or adoption or trending?

Matt Bromberg, CEO

Yes. Hi, Gili, thank you very much for the call. It's important to remember that the pricing we repealed had a real blocker baked into it. It was unattractive from a pricing perspective, and those new prices were tied to the upgrade of Unity 6. So if you didn't want to pay the new prices, all you had to do was not upgrade. That obviously was not a great dynamic from our perspective. In addition to the relationship elements and changing fundamentally how we're talking to customers, there was also a really enormous practical impact in which, for example, at our Unite conference in Barcelona, 50 customers came up and said, 'I had told everybody internally no upgrade in Unity 6, and now that you've repealed it and reverted to the subscription, we're a green light.' Those dynamics changed real radically. The most important thing from our perspective going forward is going to be stability and support, ensuring that folks can use our platform for many years and not have to make trade-offs between adopting features and stability. We spent a lot of our time talking about how we can help right now and how we can better partner with our customers. Unity 6 has been downloaded more than 500,000 times now, which is a really quick and significant number for a product that is just starting and compares favorably to some of our historical numbers in that regard. We’re also seeing it impact the velocity of the conversations around renewals and other key KPIs from that perspective. These things will take time to play out in our numbers. We did institute a significant price increase, so those conversations are going to take a little while. But having said all that, we feel like we're in a very good place.

Gili Naftalovich, Analyst

Perfect. Thanks, and one more, if I may. On your previous comments around expanding your existing customer relationships, how have your thoughts or strategy evolved around driving a stronger flywheel between the two parts of the business? What routes do you see being available to you?

Matt Bromberg, CEO

Yes. This is a little bit inside baseball, Gili, but you know that expression, 'you ship your org chart.' The first thing we did was combine the teams to understand how to deliver better products. We also merged the sales teams that are selling our core engine and editor with these game services that used to be spread out in all sorts of different ways. The execution layer of how you bring these to customers in the right way, integrated in the right way, priced the right way, is really important to having success.

Daniel Amir, VP and Head of Investor Relations

Thank you, Gili. Next question is Matthew Cost from Morgan Stanley.

Matthew Cost, Analyst

Great. Thanks for taking the question. I guess, Matt, in the prepared remarks in the shareholder letter, you sounded really enthusiastic about some of the non-gaming opportunities still ahead for the company. This is a business that's been part of the story for a long time, but it would be fair to say has scaled slower than investors hoped. So what are you seeing in that business that makes you excited about it and feel excited to recommit to it, focus on it, and try to drive growth there going forward?

Matt Bromberg, CEO

Yes, Matt, thanks so much for the question. Not to geek out too much, but the first thing that's incredibly exciting is really getting into the products that are being created and how incredible and impactful they are and how broad-based they are. Across oil, retail, and manufacturing, products are being developed on Unity every day. KLM has built these cockpit training applications that allow pilots to practice and hone their skills and enhance their situational awareness. Deutsche Bahn has used Unity to help train system simulations for train dispatchers. We've seen, in health care, a moving product launched by Charleston Hospital that was a no-cost 3D model for pediatric care, where the viewing software allowed clinicians at any hospital to interact with virtual 3D reconstructions of patient anatomy. Most of the automotive businesses globally are using Unity for new machine interfaces in their cars. This broad-based adoption is incredibly exciting. The second piece that unifies the question around the execution layer is that we have allowed our enthusiasm to make us a little more ambitious than ideal. There is a real difference between doubling down on the 3D visualization layer, importing 3D assets, manipulating those assets, and building applications on top that can be distributed through our run-time on any device. That's going to be our core business here—not getting really deep into the industrial tech stack of digital twins and simulations. The third piece is going to market in a more disciplined way, creating the right relationships with systems integrators and solution providers, so that in larger industrial opportunities, you need those partnerships to penetrate those markets. Doing that in a methodical way is starting to provide real benefits for us. So it's that kind of enthusiasm matched with focus and execution that we're really getting behind.

Matthew Cost, Analyst

Great, thank you so much. And then if I could just ask about the transition from Plus to Pro. I think we're about a year out from that where people made the transition on the old pricing. Should we expect that to be a tailwind to create revenue that you should see in the fourth quarter? Or does that play out in 2025?

Matt Bromberg, CEO

Our price increases tend to play out slowly over time, because they're tied to upgrade cycles and renewal cycles, to your point. So I think you're right to identify that as an advantage we will start seeing, but we'll start seeing that as well as the impact of our other price increases over time.

Daniel Amir, VP and Head of Investor Relations

Great. Thank you, Matt. Next question is Ross Sandler from Barclays.

Ross Sandler, Analyst

Great. Can you guys hear me?

Daniel Amir, VP and Head of Investor Relations

We can.

Matt Bromberg, CEO

Yes.

Ross Sandler, Analyst

All right. Excellent. So I've got to ask the obligatory Gen AI question. So Matt, there are a bunch of startups building asset creation tools for gaming, and there's even new environments like Google DeepMind launching something called Genie a few months ago that tap into elements of the Create stack. Admittedly, a lot of this is still pretty crude, but if you look at the pace of improvement of the diffusion models and AI in general, it gets pretty good quickly. As you look at the industry, how do you see it impacting your business and how are your customers integrating Gen AI into their workflows? How do you think this might affect your business, either from a pricing or cost perspective? And how do you see this all kind of getting integrated over the next couple of years? Thanks a lot.

Matt Bromberg, CEO

Yes. Thanks, Ross. I appreciate the question, and it's a really important one. We know that AI has a fundamental role to play with our customers in making the process of building video games faster, easier, and more engaging and innovative. We are a platform and an assembly point for games and other applications. Our extensibility is really our greatest strength. We feel perfectly positioned to help developers integrate these tools. Keep in mind that from our perspective, we're agnostic as to where and how the 3D assets get created. We're about being an assembly point, providing close control, the pipelines you need to build, helping our teams collaborate, and ultimately distributing through the run time. The explosion of Gen AI from our perspective, if it helps our customers, then we're going to benefit from a seamless integration of the best first-party and third-party AI functionality inside our editors and work to offer those to customers. We feel very good about that, and we're not fighting that at all. In fact, we're really excited about it. Our focus should be on using AI to officiate some of the complexity in our tools to help unblock and accelerate difficult, time-consuming tasks and workflows that our creators are already managing. This can have a massive effect on the equation that game companies are making. The more efficiently and quickly they can make games, the more starts we'll have, and the more innovation we'll have. I believe this is at the core of the next stage of growth for our industry. Interestingly, DeepMind is a Unity customer, and much of that work leverages our technology. We have a fundamental role to play here throughout the ecosystem, one we think we can get smarter and better at over time, and it's one we're spending a lot of time on.

Daniel Amir, VP and Head of Investor Relations

Thank you, Ross. Last question is Andrew Boone from JMP Securities.

Andrew Boone, Analyst

Thank you very much for taking my questions. I wanted to go back to pricing. Can you talk about the recent price increase that you guys made across the platform and the realization of that pricing across more enterprise accounts? How should we be thinking about that? And then for my follow-up, I’d love to ask about the go-to-market in terms of bundling, Create and Grow. How do you think about customers feeling like more of the product suite from a pricing perspective? Thanks so much.

Matt Bromberg, CEO

Thank you, Andrew. We haven't spent a lot of time thinking about how to incentivize customers to move to our Growth solutions because the best incentive you can provide customers is great performance. Our work is around making sure we deliver ROI. When we deliver ROI, customers will move to our Growth solutions. ROI on user acquisition is the lifeblood of most mobile games in the world. I don’t think we need to think about business model innovation in that respect. Product innovation is what delivers growth there over time. I’ll let Mark pick up the question about how we’re going to start to see the price increases.

Mark Barrysmith, Interim CFO

Yes, Andrew. The price increases, as we talked about, give us the opportunity to drive double-digit growth. A few things to bear in mind: the price increases don't go into effect until January 1. So this starts to roll out through 2025 as customers come to renew or upgrade at the level they're at. We see this impacting us over the next couple of years as we make our way through that renewal cycle for customers. We mentioned that we're going to return to a more consistent practice on annual price increases, which again helps us drive that double-digit growth we see the opportunity to achieve.

Daniel Amir, VP and Head of Investor Relations

Yes. This is just a double-digit growth in subscription. Just to clarify. So the last question is from Dylan Becker from William Blair.

Dylan Becker, Analyst

Thank you for your question. Matt, you've mentioned the importance of addressing the backlog. How are you viewing the significance of setting prices in a different way to demonstrate value to our consumers and customers? Additionally, how does this align with the timely hiring of a skilled team, both in terms of validating Unity's strategic role in this ecosystem?

Matt Bromberg, CEO

Yes. Thank you, Dylan. The reason I came to Unity is really because I could see very clearly how crucial the company was in the ecosystem, as you're describing. Inside an enormous vibrant market. As the question we were just taking on AI, we could go through and think about our role in the ecosystem and where it is, and it's a substantial and meaningful one. The only thing we were missing was execution and discipline and customer engagement and partner engagement around how to maximize that position—not through business model innovation or bundling—but through quality of relationships, delivering quality, and delivering value as that platform provider. The two things are fundamentally connected. The dynamics are there, and all we need to do is put together the offering—the quality of the product, the nature of the platform, and the set of relationships inside the ecosystem—and understand how we're going to deliver value and how we're going to get paid for it. Doing that thoughtfully, methodically, and meticulously was my view, and that's the biggest value creator we can provide to this company.

Daniel Amir, VP and Head of Investor Relations

Thank you, Dylan. So thank you, everybody, for dialing in today. We look forward to seeing you at one of our upcoming investor conferences that we have later this quarter that's on our website. Thank you, and have a great day.

Matt Bromberg, CEO

Thanks, everybody. Thanks all.

Mark Barrysmith, Interim CFO

Thanks all.