Management: Currently in a declining period, paying attention to the timing of recovery (Unity 4Q22 Conference Call Minutes)

The following is the minutes of the $Unity Software.USnity Software.US 4Q22 earnings call, financial report review can refer to Unity: Strong Partnership with IronSource, or Unable to Withstand the Industry Winter?

I. Key Data vs Market Expectations

1. Revenue: Quarterly revenue of 451 million USD, YoY+43%, exceeded market expectations (3.4% beat).

2. Gross Margin: Quarterly gross margin of 69%, YoY-7.7pct, lower than market expectations (-5.4pct miss).

3. Guidance:

(1) 1Q23:

  • Revenue is expected to grow YoY to 470-480 million USD, YoY+47%-50%;

  • Adjusted EBITDA is expected to be 0.07-0.12 billion USD, adjusted EBITDA% is 1%-3%.

(2) 2023:

  • Revenue is expected to grow YoY to 2.05-2.2 billion USD, YoY+47%-58%;

  • Adjusted EBITDA is expected to be 0.23-0.3 billion USD, adjusted EBITDA% is 11%-14%.

II. Earnings Call Transcript

(I) Management Remarks

The macro environment remains resilient. Game developers still have strong productivity, creating a large number of games, and investment in game development is good. DA users are strong, and the overall game industry remains strong.

Last year, digital twinning grew by over 100%, and demand remained strong. Although the sales cycle was slightly prolonged, the overall supply-demand situation puts the company in a better position.

The advertising market has been stable since mid-2022 and is still stable now. Strong user participation is offset by weaker eCPM, but it has remained stable.

We maintain a cautious and conservative attitude towards 2023 (more due to considerations of "controlling costs and setting lower expenditure budgets"), and do not make predictions about the market's expected recovery in the second half of the year. However, overall the market remains stable, and there is no cause for concern.

(II) Q&A Section

【1】Overall Performance and Outlook

Q: The Shareholder Letter mentions that pricing, China, and digital twins are the driving forces of revenue growth. Can we interpret this as: due to the change of customer base in the mobile game market, this year's seat growth will be under pressure?

A: Seat guidance is usually not provided and therefore not specifically emphasized. The company has clearly achieved user growth and continues to maintain a strong share in the game industry and on every platform.

The emphasis on pricing in China is an important driver of sequential growth. With the passage of time, it is expected that the number of seats in the professional art field will grow strongly. At present, no problems are foreseen regarding seats.

Q: What are the driving factors behind the strong growth expectations for 1Q23 EBITDA of 7-12 million US dollars and annual revenue of 230-300 million US dollars in the company's guidance?

A: It is expected that costs will remain relatively stable this year. The company has a very healthy gross profit margin, and as revenue grows each quarter, it will reach such a healthy level of profit margin.

It should be noted that cost control measures will only partially affect 1Q23, but will have an impact on the entire quarters of 2-4Q.

Q: What is the impact of tensions in Sino-US relations (such as US restrictions on chip exports and China's suggestion to suspend the big four accounting firms) on the company?

A: First, China is the world's largest gaming market.

Second, the company is an industry leader in the Chinese market.

Third, the company has changed its business structure in China and is now better prepared for long-term development than it was before.

Fourth, China has resumed issuing game licenses.

Finally, there is strong demand for digital twins from China.

In summary, the Chinese market is very important and the company has made sufficient preparations for long-term development in China.

Q: What is the company's view on the partnership with Google?

A: We have established a deep partnership with Google.

Q: Is the expected decline in 1Q23 performance compared to the previous quarter due to Create or Growth?

A: We maintain a cautious attitude towards the market, Create and Growth, especially Growth. We cannot provide guidance for 1Q23Create and Growth performance at present, but the market assumptions have been proven. 4Q has a strong seasonal impact, including the strong professional services business.

It is difficult to interpret seasonal effects in detail. At the beginning of last year, the epidemic led people to stay at home and the advertising business performed strongly. Later in the year, the advertising business became stable. In normal years, Growth generally performs best in 4Q, followed by 1Q after Christmas, and finally 2-3Q. Create in the gaming business is similar, with the best performance in 4Q; mobile games will show a more uniform performance throughout the year, but consumption in 4Q will increase.

Usually, 4Q sees a 10%-15% growth rate increase over 3Q. However, epidemics, stay-at-home orders, and economic recession have made it more difficult to judge seasonal effects.

We are currently in a typical economic downturn: game consumer participation, Create and pipeline performance outside of gaming are strong, and the advertising business based on game consumption is stable with slightly weaker eCPM. The company is closely monitoring the turning point of the recovery.

Q: Why do other companies think that the gaming advertising market is stabilizing and improving while Unity believes that the first half of the year is still difficult?

**Q: 未来投资重点;未来增长的主要驱动因素 **

A: The market is currently experiencing a decline, and investment in certain projects has had to be suspended, such as in sports and live entertainment. However, Weta remains a top priority, as it is a significant source of revenue and a great opportunity to promote the growth of professional art businesses. Most creators are not programmers, but artists, and they expect to have good art tools.

The development cycle of Grow's products is usually within one year, while the creation cycle for Create's new technology is a few years. For example, the digital twin platform has a cloud-based revenue cycle of 18 months. Therefore, this issue needs to be viewed from an ROI timeframe perspective. The investment reasons for the digital twin cloud platform are similar to those for UGS—the company has ample time. The best way to increase Create's revenue is to increase its sources of income. Currently, it has a pay-per-seat model and is looking for a second source of income.

Profitable advertising networks like LevelPay and core gaming businesses require continuous investment. The company prioritizes them based on ROI thresholds to ensure the right investment decisions are made - this is also why Unity's revenue growth is moderate while its profit YoY growth is strong.

【2】Business restructuring and development

Q: The new Create increased by approximately 9 million USD MoM and the old Create increased by approximately 13 million USD MoM. Does this mean strategic cooperation business is shrinking or UGS (Unity Gaming Services) is shrinking?

A: Strategic cooperation business performed well in 3Q22, but this is a business that will fluctuate based on the time of transaction signing. Therefore, Create needs to be evaluated independently, with actual growth being faster in 4Q22.

Q: Why merge strategic cooperation business into Create?

A: Most of the revenue from strategic cooperation business is driven by Create, so merging it can better leverage its synergies.

Q: Comparison of net expansion rates between Growth and Create; impact of new pricing measures and consumption models on non-gaming businesses; future expansion challenges

A: (1) In terms of net expansion rate, Create's net expansion speed is quite stable and healthy, with most of the cuts in the past six months coming from Growth.

(2) In terms of pricing measures, Unity's pressure is mainly on gaming business, with different business and monetization models for non-gaming businesses. The company constantly improves its customer monetization methods, and the new pricing measures mainly focus on the number of subscription seats in the gaming business.

For non-gaming businesses, efforts are focused on achieving better customer value in subscription and consumption businesses. Last year, a price increase was implemented in the game business, which seems counterintuitive, but is expected to drive continuous growth through 2023. The company fulfills existing contracts at the price set when they were signed. Therefore, as existing contracts reach their termination dates, customers renew at higher prices. Therefore, pricing is one of the factors driving growth this year.

In addition, the usage-based platform - the Digital Twin Platform - was launched in 3Q22, and many customers have already begun using it, bringing incremental revenue. It is hoped that the Digital Twin Platform will become the main business in the coming quarters and years, continuously contributing to performance.

Q: Are LevelPay's customers new or mature large-scale customers; how to obtain strategies from other platforms for publishing large-scale publishers; and what are the development strategies similar to LevelPay?

A: First, prior to the merge, LevelPlay was more successful in smaller, independent players, while Unity had relative advantages in larger players. Now there is a synergistic effect to convert more small players into Unity customers through Create to LevelPlay. Because 70%+ of mobile games are built in Unity, integrating LevelPlay into Unity is a successful strategy. It is believed that LevelPay will attract more customers, thereby increasing market share, and the engineering team is closely evaluating customer migration.

Q: What are the prospects for UGS development?

A: We are confident in the long-term growth prospects of UGS, which will become a very important business for the company. The UGS management team is very strong, and team members are driving the development and conversion of customers. UGS provides customers with high performance and good cost-effectiveness, which is highly competitive.

Q: What are the prospects for Aura's development?

A: Aura is a newly established device management business after the acquisition of ironSource, which operates at the operator level centered on the app store, generating a large amount of data and revenue. It is believed that Aura will bring huge profits.

There is a big difference between Aura and Digital Turbine (the main competitor in this field). When market share is won in this field, this share is equivalent to an operator in a major country.

The company is satisfied with itself, including Unity being a leading creative platform for two app stores, one of the industry's leading user monetization platforms, and an excellent device management platform. Especially by combining the above to create an end-to-end, highly collaborative platform, Unity stands out among competitors.

Q: What are the prospects for Weta's development?

A: First, driving the development of the professional art field does not only refer to Weta, but also to the combination of Ziva and SpeedTree with professional art.

Second, the combination of movies and games contains many business opportunities.

Third, it is expected to bring these tools to the cloud in two years, and progress is currently smooth. Q: 4Q Non-Game Business Create Performance

A: Throughout the year, the percentage of Create rose from 40% to 41% on a comparable basis, demonstrating its accelerated development. The full-year growth was 118%, with an absolute value of 70 million US dollars at the beginning of the year. We hope this momentum will continue in 2023.

【3】ironSource Merger

Q: Before ironSource, Meditation was the missing part of UGS. It is believed that this issue has been solved after the merger with ironSource. What has ironSource learned from 4Q (the quarter of ironSource's merger)? What gains can Mediation bring to the advertising market in 2023?

A: People have shown a strong interest in the merged products and aggregation tools, such as LevelPlay and two advertising websites. Meditation's market share and clients are increasing, thereby promoting monetization. These gains are not immediate and require time and effort in a phased manner after the agreement is reached.

The impact of the increase in market share in 1Q23 is minimal, but the company expects to gain market share growth in 1Q23 and the full year of 2023. Therefore, the company is confident in the overall growth of the year.

The advertising market has been stable since the middle of last year. We are indeed expecting a rebound at some point, and many people believe that it will recover by the end of this year. However, the company will not predict a recovery in 2023 because it allows the company to focus more on costs and obtain EBIT leverage from it.

In this stable advertising market, market share growth is expected for the whole year, with signs already emerging.

Overall, the integration of ironSource has progressed smoothly, and incidents such as high-level layoffs will not occur again. Tomer of Grow and Mark of Create are working hard to promote the synergies between platforms to drive the entry of clients into the market and their conversion to the company platform.

Synergy will be the focus of the next few quarters, creating a single end-to-end platform combination to provide customers with better products and services. The combination of tools and services will make the platform more powerful, and thanks to this synergy, market share will increase this year.

Q: Net retention rate excluding ironSource has dropped on a month-over-month basis. What are the net retention rate expectations for including and excluding ironSource in 2023?

A: Since the company will expand its market share in 1Q-2Q23, the net expansion rate will clearly be higher than 100% this year. Accurate figures for net expansion rates including and excluding ironSource cannot be provided. Due to the growth of market share in 1Q23 and the full year, the net expansion rate will be positive. Q: Synergy generated from ironSource acquisition

A: Currently, Meditation is winning customers, which is an important driver of EBIT growth this year. The above actually occurred after the acquisition, demonstrating the powerful strength of merging data platforms to provide high performance for customers.

The second thing Unity is doing is embedding Supersonic into the editor, making it a simple and easy-to-use platform where users can directly create products, push them to market, acquire users, and monetize.

Q: Earlier, more than 100,000 customers contributed by ironSource were 446 and now it is 284. Is this due to revenue recognition of ironSource during the acquisition or a transformation of ironSource itself?

A: Not so.

Some of ironSource's major customers are also Unity's major customers, so the numbers cannot be simply added together. Some customers have become larger for the company, but they have already been counted among customers who generated more than $100,000.

This is a very healthy combination: the company attracts new customers while penetrating more existing customers.

Q: Integration of user resources after merging ironSource; growth prospects of advertising business; benefits of Aura for Unity

A: (1) Sales, product, and engineering teams have been integrated to provide better service to customers. In terms of engineering and data, the major data integration has been completed to bring better results to customers by evaluating more data on the same problem.

In addition, Unity's advertising network tools are being applied to ironSource.

(2) In terms of Aura (non-gaming business), Aura is driving the installation of Android device games and non-gaming applications around the world, expanding advertising business.

Risk Disclosure and Statement for this article: Dolphin Disclaimer and General Disclosure