Unity: Going Light after 2024 (Unity 4Q23 Earnings Call Summary)

Here is the summary of the Earnings Call for the Fourth Quarter of 2023 for $Unity Software(U.US). For a detailed analysis of the financial report, please refer to the article "Unity Plunges? Poor Management, Weak Moves" at the following link:

（Article Link: https://longportapp.cn/zh-CN/topics/11775604 ）

I. Review of Key Financial Information:

II. Detailed Content of the Earnings Call

2.1. Key Points from Executive Statements:

1. Operational Aspects:

a) Product Portfolio: The company is focusing on a product portfolio that provides unique value to customers to ensure market success. This strategic adjustment has received positive feedback from gaming and industry clients, leading to a more streamlined cost structure.

b) Core Business: Subscription business, excluding the Chinese market, grew by 18% in the fourth quarter, showing the fastest growth and immense potential. The partnership with Capgemini is expected to further accelerate growth. Plans to surpass customer expectations with the release of the next version of Editor (Unity 6) within this year.

c) Future Expectations: Restructuring will continue into the first quarter, which may overshadow our financial progress. Strong financial performance is expected in the second half of this year.

2) Restructuring Plan:

a) Phase One: Nearly completed, focusing on resetting the product portfolio, cost structure, and refocusing on core business - engine and cloud profitability. Investments in new businesses will be reduced. This phase includes a 25% workforce reduction.

b) Phase Two: Reigniting revenue growth through a healthy financial position. Accelerated revenue growth is expected in the second half of 2024, maintaining attractive revenue levels while expanding profitability.

2.2. Q&A Analysts' Questions and Answers

Q: I would like to understand more about the detailed explanation of the 2023 figures adjusted after the product portfolio review. I noticed a $450 million decrease in revenue and a $174 million decrease in EBITDA. I tried to read the shareholder letter to understand if some of the assets you sold resulted in EBITDA losses, but specific numbers were not provided in some footnotes. Could you provide a more detailed explanation of the adjusted 2023 baseline and these adjustments?

**A: Tracking all these numbers isn't easy, so we included a table in the shareholder letter. Firstly, we had a one-time revenue from Weta FX, shown as $99 million in the table, bringing in $102 million in EBITDA, which is a one-time gain.

Secondly, the revenue change from the product restructuring you mentioned was $283 million in 2023, with most in Grow and a small portion of $15 million in Luna business. These businesses were operating at a significant loss, so we decided to divest them. We haven't provided specific numbers on this yet as it hasn't been audited.

Thirdly, pay attention to the customer credit limit, explained in the shareholder letter, and mentioned in the previous quarter's 10-Q report, with revenue at $72 million and EBITDA at $72 million.

Therefore, if you truly look at the comparable base for '23, you should start with revenue of $1.7 billion and EBITDA of $274 million, which is the foundation we are building. (See the image below)

Q: You are close to completing the strategic review (Phase One of the restructuring). I'm curious about how you consider exiting some loss-making businesses while increasing investment in core businesses. How do you balance these two aspects and integrate them into the outlook for future business growth and profit margins?

A: The key issue is that during the reset, our internal focus is on ensuring we have the ability to win with the investment portfolio we believe can succeed and ensuring we allocate the right resources for it. Therefore, this process is not about optimizing EBITDA for 2024 but about making us lean and efficient and providing resources for the areas we expect to win in.

The approach here is that we have fully funded our identified priorities and ensured they receive the appropriate support. For projects we believe will not generate returns for us or our customers, we have completely cut funding. We only invest in what we consider truly important.

By the end of the 2023 fiscal year, we should be a Rule of 40 company (revenue growth rate + EBITDA profit margin >= 40%), and we will maintain this status for quite some time, which helps you understand our company's positioning.

Q: Perhaps you mentioned some platform investments and the upgrade sales of Unity 6. I would like to understand how we should consider pricing and conversion rates? How do you drive the use of new features within the platform? Although this sounds more like a story for 2025, how does it drive momentum acceleration in the second half of this year? In addition, what are your thoughts on Unity 6?

A: We are providing resource support for both Unity 6 and Unity 7, refining the product roadmap for the core product series. For more details on this, please join us at GDC. As for pricing considerations, this indeed requires a look into 2025. We believe there is a lot of organic growth potential in our product portfolio, so we are not solely relying on price increases. Our products actually offer more value. When we look at our position in the gaming industry and discuss long-term growth, it is more related to our current product portfolio and potential future releases, rather than just pricing leverage. However, it is difficult to clearly describe the situation beyond 2025.

Nevertheless, we can see growth in our core business, particularly in core subscription services, such as the editor (excluding China), which has grown by 18%, showing a very healthy growth trajectory. It is also evident that there is still a close interaction with the editor when launching new projects, indicating that all our AI tools are receiving significant attention from customers. Therefore, as they are now using Muse, we are satisfied with the progress we are making.

Q: The shareholder letter mentioned a reacceleration of growth in the second half of the year. Could you further explain this? What are the main drivers of this growth? Is it mainly due to operating expenses? Is it because of the release of Unity 6, or are there other factors driving this, such as the industry growth you mentioned?

A: Runtime fees did not have a significant impact in the second half of the year. The confidence in the acceleration is mainly due to the backend innovations we are bringing to all product lines, some innovations in growth, making our products more competitive in terms of data, performance, and return on advertising investment.

Therefore, we are taking a lot of measures to drive accelerated growth in our business. We are innovating in the gaming business and other industries, and through these innovations, we expect to drive business growth.

Additionally, we are undergoing a company restructuring, which is a comprehensive transformation process. Therefore, in the first half of the year, we took a rather conservative approach, especially in terms of layoffs, as this often distracts attention. However, our expectations for the future market and business are positive, which is why we are confident in the performance in the second half of the year. Of course, there are still some distractions at present, but we expect to complete the company restructuring by the end of the year.

Q: It sounds like there is also growth in business growth. When discussing the sustainability of growth, is it because developers are satisfied with the way Runtime Fees are introduced? Or is it more about what you mentioned, integrating development toolsets and making business growth more data-driven and competitive?

A: (Regarding the introduction of Runtime fees) We have not seen a significant impact. There was an impact in the past, but as we entered 2024, it was not guided by the business units. We expect improvements in both businesses throughout the entire year.Last year, we did a lot of integration work with ironSource Unity. In this context, there may have been a slight decrease in focus on driving progress, which I believe led to some delays in our progress. However, that situation is now behind us. We have integrated the team and developed a plan that I am very confident in, as reflected in the growth at the end of the year.

Q: Regarding the progress of the ironSource integration: The integration was not immediately completed after the acquisition of ironSource, which may have caused some delays. It seems that you now feel the acquisition is completed. I also noticed that some key personnel have left ironSource. Could you please elaborate on this? Is there any relevant information you can share?

About the $72 million credit line: Was this set up earlier to encourage people to use the LevelPlay platform? Why is this plan being canceled now?

A: When two companies merge, the first priority is to retain the right talent, maintain business continuity, and then integrate the various parts over time. So last year, we have been working on this, and it finally culminated at the end of last year. By January, as part of our overall restructuring, we became more of a functional organization. Therefore, we unified all ownership of Unity and ironSource in the commercial department or CRO of the advertising business for the first time.

We now have a unified leadership team in product and technology as well. Frankly, until January, we had two data science teams, which are now merged into one. We used to have two separate data engineering teams, and now there is only one. Therefore, the arrangements and implementation of the acquisition naturally take time, but we have completed it now, and we believe these unified teams and focus will benefit us. In this process, the founders of ironSource are also stepping aside to provide more opportunities for people within ironSource. I still keep in touch with many of these leaders weekly. They are very concerned about the success of ironSource and the future success of Unity.

Regarding the second part of your question, we have been communicating recently that before the merger, ironSource provided some incentives to their customers, and some integration fees were refunded to us, which we have recorded as revenue throughout the year.

Therefore, we want to ensure that you have full transparency on these amounts, and we have included this information in the table showing Grow's quarterly revenue. So, most of the difference between the numbers we report is the refunded integration fees.

The only difference is the $15 million from Luna, which is essentially spread over the whole year. You can assume it is around $3 to $4 million per quarter.All content except for the integration fees refunded to Unity.

Q: Regarding the annual revenue and profit margin guidance, you mentioned expecting an EBITDA profit margin of over 25% in the fourth quarter. It seems like a predictable trend, indicating a potential further increase in profit margin by the fourth quarter. I would like to know if this situation may be due to the diminishing benefits of reducing staff in the second half of the year, or because of reinvesting funds into the business? So, the first question is about the EBITDA profit margin.

A: We will include our guidance. We also aim to ensure that we reinvest funds appropriately, as mentioned in the first question during the meeting, we are finding the right balance. We aspire to be a Rule of 40 company, and we believe we can approach this benchmark by the end of the year. This is the goal we are striving to achieve, and we clearly see the path to achieving it. While we are working hard to drive our profit margins and cost efficiency, we will never sacrifice growth.

Q: If possible, the last question is about the competitive environment. You mentioned in the shareholder letter the impact of competitive intensity on the business. Could you elaborate on this?

A: In terms of growth, we do see a more intense competitive environment. You may have noticed some competitors releasing performance reports, some of which outperform ours. However, some of the innovative products we have launched have performed well, and we have been busy with integration work before, but now we are very organized. We are aware of the gaps and have proactive plans to address them in a short time.

Q: Let's first talk about the multiplayer gaming business. You mentioned shifting services to Orchestration and hosting solutions. Could you explain this in detail? And perhaps shed some light on how we should consider the future profit margin allocation for this business?

A: As for our multiplayer gaming business, it actually involves two aspects.

The first is hardware components, but this is not our strength. This business cannot bring us good returns or provide services to customers at competitive prices, so we have decided to no longer invest in it.

However, where we provide unique value is in the management and coordination layer of multiplayer gaming. This is the area we continue to focus on because it is a software business, profitable, and we can provide unique services to customers. Therefore, we decided to exit the hardware business because we believe the software layer is where we uniquely provide value to customers.

Q: You mentioned growth in the engine business outside of China. But I would like to understand more about the strong performance of game advertising spending in China that we hear about in the industry. Could you talk about your performance in the fourth quarter and the opportunities for Unity in the future?

A: Therefore, for the Chinese market, you need to think from a different perspective. In terms of the creation business, it mainly refers to our customers in China developing games within China. As we know, there are some restrictions in the Chinese market that have been affecting our growth in the creation aspect.When it comes to growth, our growth in the Chinese market comes from two factors: one is the domestic business in China, and the other is the overseas business of Chinese customers. The performance in these two aspects is equally strong as in other regions.

Q: The first question, will the streamlining of product portfolio change the development trajectory of non-gaming industry businesses? The second question, regarding professional services, especially the collaboration with Capgemini, how should we view it? Are there any strategic changes or other important matters to note?

A: Obviously, professional services involve significant funding, so revenue will decrease. However, this is also why we have shown this adjustment in the data. In terms of our Strategy portfolio, apart from the solutions we can provide, there are hardly any other convincing options. Starting from visualization, our focus is on how to offer a more comprehensive product view to connect with end customers, involving configuration, distribution, and even design aspects.

In all these discussions, the importance of visualization in solutions can be seen. It not only deepens interaction with customers but also helps build rich educational content. Therefore, like other infrastructure software companies, we heavily rely on partners in marketing because building these solutions is not our forte.

Hence, we have decided to become a software company and double down on delivering excellent software. By collaborating with partners like Capgemini who can apply the software to building solutions, which is their expertise, we aim to significantly accelerate this business.

Clearly, as a software company, we have higher profit margins. However, considering infrastructure software companies, if we consider visualization and our work as part of the infrastructure, almost all software companies engaged in such work heavily depend on partners. Through collaboration with partners like Capgemini, we will gain better distribution channels; by working with those focused on providing solutions, we will achieve better outcomes and scale; Capgemini can provide more manpower for this.

Therefore, non-gaming enterprise customer sales present a huge opportunity for us. We need to recognize that we are a software company and establish an efficient and effective marketing approach to provide infrastructure solutions to customers, with Capgemini being a part of it. Some customers are very excited about this because they know we excel in building interactive 3D software rather than their industry-specific solutions.

Q: In the opening paragraph of the shareholder letter, you mentioned that you believe this could be bigger than the gaming business. So, have you seen any specific use cases or industry verticals where you think you can gain high recognition, and do you have confidence that it can gradually grow from 23% of subscription business to become the main business?

A: I would like to briefly introduce a few usage scenarios, let me explain with some examples. Firstly, many luxury goods retailers may not have their entire inventory in every store, but they aim to provide a rich experience for customers to thoroughly examine their products. This scenario involves various products, from jewelry to clothing. We have observed many customers using our technology by placing iPads in stores, allowing customers to have a real-time immersive experience. With this setup, users can rotate products, zoom in to see details, and interact with the products.

Currently, there is no other way on iPads to achieve this in a high-performance manner. I know it sounds simple, but to have a real-time engine efficient enough for users to rotate and zoom in on products in real-time, we are the best choice. Therefore, a range of luxury goods retailers have recognized this. Of course, this demand is not limited to luxury goods retail.

In the industrial field, we see customers saying, "Hey, we have 10 different PLM systems or CAD/CAM systems. We want a visual layer that can retrieve data from all these systems and widely provide it to end-users or engineers within the company."

Another example, such as in the automotive, aerospace industries, we have seen many companies interested in us becoming their visualization solution. For instance, if you use a $5000 workstation in AutoCAD, you can interactively rotate in real-time 3D. But when you want to showcase this content to people, whether through a web browser, iPad, or mobile phone, we are the best solution. Therefore, in all types of industries, whether automotive, aerospace, etc., people have shown great interest in us becoming the visualization solution for these markets.

Lastly, talking about education and training, especially in the AR/VR field, I have had discussions with a large construction company that is using this technology. So when a worker arrives on-site, they can put on a VR headset to have an intuitive feel for the appearance of certain facilities. This technology can be used for training, especially in high-risk environments like nuclear power plants. The application of AR/VR technology is very interesting. I believe with the launch of Vision Pro, people are very interested in some consumer use cases, but we are also excited to collaborate with Apple to explore its applications in the industry. These are three examples.

To reiterate, we are not just an ordinary participant in this field. We are almost the only one capable of achieving real-time interactive 3D effects on lightweight devices, such as web browsers, iPads, and mobile phones. This is why enterprises have shown such strong interest in us in these types of use cases. Clearly, with the increasing digital twinning worldwide, both products and supply chains are becoming more digitally connected, creating more and more opportunities for us.

Q: When it comes to growth, there seems to be a significant gap between the growth rate of public competitors expanding their advertising networks and Grow's recent performance. However, I see this as a great opportunity for Grow to catch up. Do you see any specific changes in investment or marketing strategies in the competitive landscape? Perhaps there are new technologies you are particularly focused on to narrow this gap. Is there anything you would like to elaborate on?

A: We have made significant incremental investments in technology, including our data stack and data processing capabilities. We are also investing in product suites to ensure that we can best acquire the data that is most helpful in improving the data science efficiency for our monetizing clients. These investments, I must say, are all additional investments.

However, when we consider the completion of the ironSource-Unity merger, we did not directly convert some of the synergies into profits, but reinvested the additional income generated from these synergies to fund faster feature velocity, to bridge the gap and take a leading position in these areas.

At the same time, our clients have confidence in our long-term development in the advertising network, which also gives me confidence in our continuous improvement in this area and the desire to move forward together.

Q: Previously, we discussed finding the right key performance indicators (KPIs) and measuring based on them. Have we reached a consensus on which KPIs are more appropriate? Are we still focusing on previous metrics such as the number of customers exceeding $100,000, the number of customers with annual revenue exceeding $100,000, and the dollar-based net expansion rate? Or are these metrics independent and will be provided regardless?

A: I believe there are several important indicators that we have shared with everyone before. I think the "industry business ratio" is important, as well as the TAM reachable scale we have discussed, the number of customers, and the net expansion rate are also good indicators.

However, the "industry ratio" figure is a bit tricky as it involves the entire company, so it is not as representative as other indicators.

We have also been talking about market share, how many of the top 1,000 games are developed using Unity, which is a good measure of community engagement. Therefore, we will continue to provide these indicators and add some new ones as we make progress across industries.

End of transcript

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