Unity:Be More Nimble and Focused

Unity 2023 Q3 Earnings Call Summary

Management Report

1.James Whitehurst (CEO) Speech

(1) I have been with Unity for over a month now, and I would like to highlight three points:

Firstly, I am deeply impressed by the passion of the Unity community and the company itself. Our current focus is to build Unity into a top-notch platform that supports developers throughout the entire process from design to monetization.

Secondly, the world has changed, and we are changing with it. We have made significant efforts to reduce costs and transform Unity from a cash-consuming company to a cash-flow positive one. We have reevaluated the company from top to bottom, striving to make it more agile and focused.

Thirdly, we will concentrate on the continuous growth of our business. By refining our leading-edge technology to serve our customers, we will achieve success, which will naturally lead to increased profitability.

(2) Vision for the next 3-5 years

Having previously managed a community-based business, I naturally pay more attention to the community aspect.

In simple terms, I hope that in 5 years, we will become a developer community based on our technology, a trusted leader in technology. We will be an indispensable partner for developers throughout the process of building, operating, and monetizing their games. This alone represents a market worth hundreds of billions.

Furthermore, I hope to see our technology become the default choice for enterprises and individual developers when creating 3D interactive content. This is also a huge market with untapped potential.

2. Richard Davis Speech

We will be making adjustments to Unity's business in Q4 (divesting from non-profitable businesses), and we expect these adjustments to be fully implemented by the end of Q1.

In addition, we will continue to optimize our cost structure to improve profit margins. This will result in a reduction in personnel and office locations. We will announce this news in the coming months.

Analyst Q&A

Q1: In the shareholder letter, there were many descriptions about narrowing the business scope and focusing on core businesses. However, a month later, there may be some initiatives underway. How do you view this business? Will you utilize some of the methods you have seen before?

A: Narrowing the scope is about ensuring that we fully leverage the potential of our core business before getting busy with other things. The second point is to strengthen execution. We need to concentrate our efforts, establish the right key performance indicators, tighten our belts, and execute these initiatives.

To put it simply, when I first joined Red Hat, they had a leading product called Red Hat Enterprise Linux.But we are currently spending a lot of time doing 5, 6, or 7 things at once. The management's time and attention have become scattered, but focusing on what you can succeed in is the key.

Now, U is somewhat similar to Red Hat, both in terms of leading products and doing many other things and losing focus. Therefore, it is only natural that we are now truly seeking to build an efficient product and an effective operating model around these things.

Q2: You mentioned the need to strengthen the business connection between Create and Grow. How do you view the synergistic value generated by the entire platform over time?

A: First of all, we are committed to building an operating model that drives value for both the "Create" and "Grow" businesses. We have always been committed to the integration of people and things, but what we are really building is a flywheel. We are still in the process of integration, disconnected and with only one perspective on customers, so we can discuss how to help them best create value from development and monetize it.

We are very unique, knowing that we have over 70% market share in the mobile engine, which has laid a very solid foundation for us.

Q3: You mentioned that the impact of the changes in the charging policy in the fourth quarter was limited. What measures have you taken to engage game developers and rebuild trust with them?

A: I have had discussions with many developers, and at first, most of them were negative about our initial actions. However, if we let them continue to pay attention to our subsequent actions, they will understand the first actions we took.

Therefore, I think our subsequent adjustments are very important and helpful in changing customers' perceptions. But the most helpful thing is that we will be launching some important new features in the future. For example, in the process of communicating with a developer, at first, this game developer was very negative, but when they heard that we were pushing for the implementation of new features, they suddenly became interested in becoming our early beta testers.

In the past, when dealing with the community, we could talk about everything we wanted, but our actions are how we will rebuild trust, and these actions are how we make future decisions and effectively utilize and reinvest these funds to create extraordinary products. Therefore, next week, we will be launching a series of products.

Q4: I think many investors are curious about the decision to cancel this year's guidance. Is this the best execution idea you chose when evaluating the business as the new CEO?

A: I know many people are angry about this, but I want to make adjustments quickly (reducing the scope of business, stopping some businesses). If the action is slower, it may make short-term revenue look good, but it will affect the speed of our adjustments. If we don't make these adjustments early, the whole process may end up taking a long time.

But after the adjustments are completed, we will continue to disclose guidance. We expect to disclose guidance for the first quarter and the full year of next year in the fourth quarter.Q5: How did the UGS business perform relative to expectations this quarter, and is there any waiting for this part of the business? Can you comment on ironSource's cross-selling opportunities and the current status of this business? When you said in the shareholder letter that the company did not achieve the synergies that exist in the entire investment portfolio, are we correctly assuming that this is what you meant? Or perhaps this is the reason for the weak growth of UGS?

A: The performance of the UGS business this quarter did not meet our expectations. I believe that UGS has been very successful in sales in the gaming field, but if you really observe the correlation between things produced by Unity Games such as Multiplay and Unity, you will find that it is actually quite low.

Therefore, I want to make sure that what we are doing is what we have the right to win, and that is around our Unity ecosystem. I'm not saying that the revenue from selling multiplayer games in Unreal will be bad, but fundamentally, where we should be able to win is where Unity has an advantage. In our investment portfolio, the focus is on ensuring that what we do is self-reinforcing.

Progress has been made in integrating ironSource, but much of it is about integrating core content together. Now, getting the flywheel that we believe can truly synergize between the editor and the runtime, and the Grow business is something we have just started.

Q6: How do you start narrowing the gap between the currently high and dominant developer share and your current revenue share? Is a variable profit model like charging by runtime really the key to unlocking this advantage? Are there any other adjustments needed to ensure its growth when you look at this business?

A: This is a market that is bigger than the gaming market itself for us, and the gaming market is a low-profit market, so when you want to change the price by one point, it's obvious that you will encounter resistance.

But from another perspective, our market share is very small, less than 1% in the current potential market size of 100 billion. So we can push for more user penetration, such as promoting DevOps or automated testing, or considering other features that developers may need, especially for teams focused on developer security, compliance, and identity management. We won't raise prices for these things.

I think charging by runtime is important, as it allows us to make developers aware of the value of runtime, such as the need to speed up the execution of related functions, in order to explain to customers why there is a charge.

Looking ahead, it is important to provide more runtime capabilities and how to scale.

Q7: Regarding the latest information on AI products, how is the progress of the internal testing so far? When can these tools be officially launched after testing?

A: We will share that next week in Amsterdam, so I won't reveal it here in advance.Q8: James, will you accept the permanent position of CEO in the next six months or so? How can we achieve closer integration and synergy between the "Create" and "Grow" businesses? With the enhancement of synergy, what should we do next? How is it reflected?

A: For the first question, I respect the board and the process they are going through.

As for the second question, in terms of closer integration, what we are striving to do is to help game developers achieve maximum success. I understand that, in some ways, it is a great art. But for others, it's about making money, that's where monetization and ad segments come into play.

In fact, based on our understanding of how people play games and the analysis we have provided to developers who use our analytics products, we are thinking about how the engine works, how engagement works, and how people use games. If we can align the flywheel with that, it can better help them monetize ad space and obviously profit from it. We are still in the early stages.

Q9: What other costs need to be reduced in the business? I have seen that you have already made some layoffs. You hope the company becomes a leaner organization. What will support the long-term development you just envisioned?

A: I come from the airline industry, so I pay great attention to optimizing our operational efficiency. The solution is to establish an operational model and organizational structure that focuses on core business. This naturally leads to greater efficiency.

This is a different approach from before. It's not about spending more money to support revenue growth, as that doesn't necessarily mean you will make money. What's more important is to become efficient first and then scale up.

So I call this operational mindset a reset. The entire company will become more efficient, and we will establish an operational model that is more suitable for our business, and then continue to expand. There is great growth potential in the future. Although the process is painful, I believe we will soon overcome this challenge.

Q10: How specifically will we optimize costs?

A: First, we are implementing a different investment strategy - exiting non-core businesses.

The second thing is to continue to promote collaboration between teams and improve the efficiency of different teams.

Lastly, we are re-evaluating G&A and how we can continue to optimize it, so that most of the funds are used to invest in products that customers love and drive our revenue, profit, and cash flow.

Q11: Can you provide a timeline for when we can expect the growth to accelerate to help alleviate investors' concerns about the lack of progress in recent data?

A: I believe that as long as we operate with more focus, you will see overall improvement in 2024. However, we need to execute a series of growth-driving initiatives. As for the timeline for accelerated growth, we can provide more detailed information when we discuss the quarterly report in February next year. Without the complete numbers ready to discuss, I still have confidence in the next year.We will make every effort to achieve strong growth in 2024.

Q12: When the company chooses to divest some business investments, are there any protective measures in place to prevent free cash flow/adjusted EBITDA from becoming negative? Or do we have to go through a period of relatively weak financial indicators and expect better performance prospects in 2024 and 2025?

A: It is more about divesting from some of the unprofitable things we are doing. Therefore, I believe that even in the fourth quarter, adjusted EBITDA will not show a real decline.

This is not a transformation of the business model that requires one, two, or three years, but perhaps only 1-2 quarters. Of course, the first quarter may not have fully completed the business adjustment, but we believe that the profit margin in the second quarter of next year may be similar to that of the fourth quarter.

Finally, I would like to emphasize once again that I spoke frankly about the business adjustment at the beginning of the conference call. Compared to a month ago, I am increasingly excited and confident about the company's long-term growth opportunities. In my opinion, Unity has a very strong and solid technological moat. Today, there is no opportunity to discuss this in depth with you.

But due to the technological barriers and the platform nature of the company itself, its competitive defense capability in the real-time 3D field is very strong. Unity is indeed the only provider for customers to achieve cross-platform real-time 3D capabilities. So in many areas, such as consumer goods companies, industrial companies, and the gaming industry, we have many opportunities.

But for our key core, it is important to ensure that we establish a path to sustainable profitability by executing each task in order, so that we can continue to provide relatively clear and transparent outlook and guidance.

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