Unity: Too early to talk about goals, execution is the top priority now (2Q24 conference call minutes)

Below is the summary of the second quarter performance conference call of Unity Software in 2024. For a review of financial reports, please refer to "Unreasonable Surge, But Promising Future for the 'New' Unity".

I. Financial Indicators Overview

II. Management Report

1. CEO Speech: Overview and Strategic Goals

In the next chapter of Unity's history, we are committed to innovating to make a significant impact on our customers and community. Our next-generation engine version, Unity 6, is set to be released this autumn, and we are confident that it will be the most stable and best-performing version. The initial debut in May has already attracted many developers, and Unity 6 will be a driving force for our growth in the coming years.

As for the advertising business, we have been informed by customers that there have been some improvements in the product, including alliance advertising and intermediary platforms. We plan to rebuild the machine learning stack and data infrastructure to achieve better product performance. We are designing a more agile, innovation-friendly, and cost-effective infrastructure that also facilitates the integration of data from our different products, unlocking greater value for our customers.

We are also bringing in more global talent to help accelerate the transformation of our advertising business. Today, we are pleased to announce that Jim Payne has joined us as the new CPO of our advertising business. He is well-versed in product design and advertising business and understands better than anyone how publishers can expand their revenue.

In July, another advertising veteran, Alex Blum, will also join Unity as SVP. There is still significant growth potential in mobile marketing, and the addition of these two individuals will help us seize this opportunity.

Our entire team faces challenges from companies around the world with the best technology. But we play a unique role in the entire ecosystem, with a presence in mobile interaction, 3D, gaming, AI, data, and digital advertising.

We will achieve our long-term value through better execution, faster product innovation, and a renewed focus on our customers and community.

2. CFO Speech: Financial Performance

(1) Revenue: Strategic portfolio revenue in the second quarter was $426 million, a 6% year-on-year decrease, compared to the previous guidance of $4.2-4.25 billion.其中， a. Create revenue was 129 million, a year-on-year increase of 4%. The growth relied on a 14% increase in subscription revenue, mainly benefiting from price increases and package upgrades. It decreased by 2% quarter-on-quarter, mainly due to reductions in strategic partnerships and professional services.

Non-gaming revenue is our fastest-growing business, with a year-on-year growth of 59% in the second quarter, contributing 18% to the overall Create revenue, compared to only 12% last year.

b. Grow revenue was 296 million, a year-on-year decline of 9%, with a 1% increase quarter-on-quarter. We are quite satisfied with achieving a quarter-on-quarter growth after two consecutive quarters of decline, mainly benefiting from product improvements and seasonal characteristics. From a year-on-year perspective, the decline is still due to pressure on the monetization business, offsetting the strong growth driven by Aura.

(2) Profit: Total GAAP net loss was 126 million, a 35% improvement compared to 193 million in the same period last year. Adjusted EBITDA was 113 million, a 29% year-on-year increase, with guidance of 76.5 to 80 million. This is mainly due to our continued reduction in operating expenses and expanding gross profit margins. The second-quarter Non-GAAP gross margin increased from 81% last year to 84%.

The increase in gross margin comes from cost control and changes in product structure, as well as adding more cloud capacity to train our machine learning models.

We will continue to strategically manage operating expenses, deciding which areas of spending need to grow, which to maintain stability, and which to continue to shrink. Ultimately, Non-GAAP operating expenses decreased by 21% year-on-year, with the expense-to-revenue ratio decreasing from 63% to 59%. The adjusted EBITDA profit margin for this quarter reached 25%, an increase of 850bps year-on-year.

(3) Cash Flow: Free cash flow in the second quarter was 80 million, a 137% year-on-year increase, with cash and cash equivalents of 1.3 billion at the end of the quarter.

(4) Shares: The total diluted shares after potential dilution were 476.5 million, a slight decrease year-on-year. Our previous guidance was 480 million.

(5) Outlook:

a. Third Quarter Outlook: Strategic portfolio revenue of 415-420 million, a year-on-year decline of 4%-6%. However, engine subscription revenue in Create can maintain double-digit year-on-year growth. The Grow business will need more time to recover.

Adjusted EBITDA for the third quarter is 75-80 million, including the need for additional investment to strengthen the Grow business.

b. Full Year 2024 Outlook: Strategic portfolio revenue of 1.68-1.69 billion, a year-on-year decline of 2%-3%, with the original guidance range being 1.76-1.8 billion. This is mainly considering the recovery time for the Grow business, so the impact is cautiously taken into account. However, engine subscription revenue in Create can maintain double-digit year-on-year growth.

For the full year, adjusted EBITDA is 340-350 million, with the original guidance being 400-425 million. To mitigate the impact of reduced revenue, we will further save costs of 5-15 million to ensure overall monetization efficiency is higher

c. Share Outlook: It is expected that the total number of shares after dilution will be 488 million by the end of the year, a slight decrease compared to 492 million at the end of last year, reflecting an annual dilution rate of 2%.

III. Analyst Q&A

Q1: Regarding the advertising business. You mentioned in the shareholder letter that you want to rebuild the machine learning and data stack. Can you provide a clearer growth blueprint and framework for us? Is rebuilding a potential long-term ongoing process? What are the priority investments?

A: We have been accelerating the development and launch of advertising-related products, integrating multiple advertising support units on the intermediary platform. We have made many adjustments to the model and have received positive feedback from customers, which encourages us to continue moving forward.

At the same time, we also feel the need to do some foundational work, like I mentioned in my letter, machine learning and data basic stack. Because having differential basic technological capabilities will help us succeed in the long term, we are very excited about this opportunity, will soon put it into practice, and are very much looking forward to the positive impact it will have in the future.

Q2: About Create growth guidance. Can we assume that the mid-term perspective of Create business growth can also achieve double-digit growth?

A: What I mentioned is double-digit growth in subscription revenue in the Create business. As you know, Create includes three business segments: subscriptions, professional services, and strategic partnerships.

Professional services and strategic partnerships will continue to be unstable, strong in Q1, weaker in Q2, fluctuating due to our cooperation agreements. So, you should have strong expectations for continuous growth in subscription revenue.

I think it's too early to say specifically how things will be in 2025. We should give Matt (the new CFO) more time to set and assess this goal, and when we have done the evaluation, we will come back in time to share our expectations for next year with everyone.

Q3: About Unity 6 and Create growth. The next quarter's Runtime fees will be launched along with Unity 6, including the potential price increase effect of Plus shifting to Pro. How should we consider driving Create revenue growth?

A: The trend of price increases needs time to manifest and is not simply following the package upgrade cycle. We do not expect it to happen immediately in the short term, but price increases will definitely occur over time. Currently, we are mainly benefiting from the unified price increase two years ago, followed by the price increase brought by customers upgrading their packages.

Q4: About the Rule of 40. I saw you used the Rule of 40 a few quarters ago, do you still use this to evaluate business development?

A: The Rule of 40 (the sum of revenue growth rate and profit margin exceeds 40) is a very correct target, reflecting a business that is highly attractive in growth and has decent profitability, which is the goal we have always wanted to focus on achieving.

We focus on achieving long-term sustainable growth, both in revenue and profit. But for us now, it is too early to accurately predict what level we will reach, but this is indeed something we need to focus on

Q5: Regarding competition with Applovin. Do you think you need to modify the model to make your product more competitive? What assets do you think your advertising business is still lacking to qualify you to return to the table?

A: In terms of competition, our position is unique. We are the only company globally that can provide full lifecycle technical service support for games, and customers also prefer each link to be integrated into a complete solution.

In fact, we are continuously updating our model and launching new products. However, at the same time, we need to ensure that we have the most modern and best-performing data and machine learning technology.

Being able to respond in real-time and leverage data advantages is not only reflected in the engine but also in our advertising network and three to four ad products. We have the world's largest database, the most understanding of videos and customers, and we can leverage these to deliver greater value to our customers. This is very important in the long term, a rare and important asset, and also our opportunity.

Q6: Regarding the application of the engine in the industrial field. You mentioned that outside the gaming industry, Create is still growing rapidly, how will this affect your resource allocation?

A: We attract globally renowned expert talents to join, Jim is a good example. Secondly, we tilt resources towards accelerating product innovation, focusing on rebuilding deep cooperative relationships with customers, and listening to the needs of partners and customers.

Q7: About guidance adjustments. Is the downward adjustment of guidance due to cautious consideration, is it a momentary consideration, or is it based on a linear trend derived from some changes?

A: As you said, we are mainly more cautious. You can see from Q3 and Q4, we actually guided a relatively stable trend, the difference between seasons is just a few million, which is very stable.

Mainly because we did not see too many seasonal changes in the second quarter, if there were any, that would be great. But for the recovery of the Grow business, we are still quite cautious.

Comparatively, our main focus now is to restore our reputation and credibility in the ecosystem, so taking a cautious approach to forecasting is more important and correct for us.

Q8: About the growth of Create in non-gaming areas. You mentioned a 60% growth in industries outside of gaming, with an increased share in Create. I know Jim has talked a lot about opportunities in the Industry, but I want to know if you have seen a continuous increase and penetration of partners? Have you established a broader ecosystem by selling the digital twin Professional services department to Capgemini?

A: Thank you for your question. Yes, we are very excited about the opportunities in the industrial sector, and we continue to see real progress there, focusing on specific end markets such as automotive, retail, and manufacturing. But in fact, more broadly, 3D asset visualization across devices and platforms is valuable anywhere - these are very broad applications. So we see very strong demand We have added many new customers in the second quarter, including Audi, Diageo, as well as German engineering companies and Bosch Rexroth. Therefore, we continue to see growth and momentum there. I am very, very excited about this, and I know Jim is very optimistic about it. We are fortunate to be able to leverage his expertise and continue to do so. But this business is a real opportunity for us, and we are working hard to seize it.

Q9: From the shareholder letter, it seems that the management has a new look, but I am not sure if there will be any changes in the future. So, what is the script for Unity to return to excellence? Do you have confidence in specific execution?

A: We are building a culture that is executable and accountable within the company, which is not entirely the same as what we have shown to the market in the past. We are rapidly adding top talent globally and bringing in new leaders to the company. We will better listen to customer needs and be more responsible. You will soon see us launch more product innovations, and we will share our experiences with you at that time.

The restructuring has been going on for 90 days, and we do not want this process to be too long. However, as I mentioned in the letter, we firmly believe that we are the only company in the world that can occupy such an important position in such a huge market.

So, we are in a favorable position, and I see all the elements here: talent, technology, assets.

Our partners want us to succeed in both businesses. In the advertising business, people want us to be a strong competitor. The same goes for our engine business. We have the support of our customers, we have all the components, all we have to do is execute, and we have the confidence to execute.

Q10: Everyone is interested in Create's non-gaming market, and in Q2, non-gaming revenue also grew the fastest, reaching 60%. But at the same time, you also mentioned the need to repair relationships with gaming customers and invest in improving advertising products. How do you view the future investment in non-gaming market business?

A: The non-gaming industry business is a natural extension of our gaming customer development capabilities. I don't think the two businesses are contradictory, and some of the product improvements and infrastructure investments we are currently making can also benefit the Industry.

So from our perspective, I don't think we lack enthusiasm for the Industry business, as we have already had many discussions about Industry in the past. But the focus now is on execution, executing the process of bringing good products to market.

Of course, we currently have enough resources to invest in the second task, Industry, because this is a business that naturally extends from us.

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