Unity Software Inc. — Q2 2022 Form 10-Q
Business context and reporting period. Unity provides software to create, operate, and monetize interactive 2D and real-time 3D content. This unaudited quarterly report covers the three and six months ended June 30, 2022; comparisons are with the corresponding 2021 periods unless stated otherwise. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Revenue | $297.0 million | $273.6 million | $617.2 million | $508.3 million |
| Gross profit | $200.2 million | $215.8 million | $426.5 million | $391.9 million |
| Gross margin | 67% | 79% | 69% | 77% |
| Loss from operations | $(197.7) million | $(149.2) million | $(368.8) million | $(260.1) million |
| Net loss | $(204.2) million | $(148.3) million | $(381.7) million | $(255.8) million |
| Diluted net loss per share | $(0.69) | $(0.53) | $(1.29) | $(0.92) |
Q2 revenue rose about 9% year over year, while six-month revenue rose about 21%. Create Solutions revenue increased to $120.9 million in Q2 from $72.6 million; Operate Solutions revenue declined to $158.5 million from $182.9 million. Strategic Partnerships and Other revenue was $17.7 million, versus $18.0 million.
For the six months, operating cash flow was positive $58.4 million, compared with cash used of $115.6 million in 2021. Free cash flow, a non-GAAP measure defined by Unity as operating cash flow less property and equipment purchases, was $28.1 million versus negative $134.1 million. Management attributed the improvement primarily to a roughly $200 million prepayment of four years of Weta FX license fees, partly offset by the annual bonus payment, net loss, software-license prepayments, and working-capital needs.
At June 30, cash and cash equivalents were $1.162 billion and marketable securities were $591.5 million. Current assets were $2.158 billion and current liabilities were $626.5 million. Convertible notes had a $1.725 billion principal balance and a $1.705 billion carrying value; the 0% notes mature in 2026. Stockholders’ equity was $2.282 billion, and accumulated deficit was $1.713 billion.
Material changes and management commentary
- Revenue growth came primarily from new and existing Create Solutions customers. Management said Operate Solutions faced product challenges, with revenue declining in Q2 and growing only slightly for the first half.
- Unity cited a platform fault that reduced the accuracy of a monetization tool and bad data from a large customer. It focused on remediation during Q2 and reported signs of improvement in June. Management expected the recovery to extend at least through Q4 2022.
- Dollar-based net expansion rate fell to 121% from 142%. Customers generating more than $100,000 of trailing-12-month revenue increased to 1,085 from 888, but management noted slower growth amid Operate Solutions challenges.
- Costs pressured margins: Q2 cost of revenue rose to $96.8 million from $57.7 million. The company cited higher personnel costs, acquired-intangible amortization, and professional-services fees. Research and development and sales and marketing expenses also increased, reflecting headcount and investment.
- Q2 GAAP net loss included $118.2 million of stock-based compensation for the quarter. Non-GAAP operating loss was $44.1 million, versus $0.7 million in Q2 2021; non-GAAP net loss was $53.1 million, versus $1.3 million. These measures exclude specified costs, including stock compensation and acquired-intangible amortization, and should not replace GAAP results.
Outlook, transactions, risks, and unusual items
- Unity provided no clear quantified forward financial guidance in the supplied filing text. It said it expected GAAP operating losses for the foreseeable future as it continued investing in research and development, sales and marketing, and general and administrative functions. It believed existing liquidity would cover working capital and capital expenditures for at least 12 months.
- Management flagged negative macroeconomic factors, foreign-exchange effects from a strong U.S. dollar, and uncertainty around COVID-19 and the return to offices. It said macroeconomic pressures could particularly affect Operate Solutions and advertising demand.
- On July 13, 2022, after quarter-end, Unity agreed to acquire ironSource in a stock transaction. The filing estimated consideration at approximately $5.8 billion based on Unity’s August 8 share price and anticipated closing in Q4 2022, subject to approvals and other conditions. The proposed deal is not reflected as a completed acquisition in Q2 results.
- In connection with the proposed deal, Unity agreed to issue $1.0 billion of 2.0% convertible notes due 2027, contingent on closing, and authorized a post-close share repurchase program of up to $2.5 billion. The filing said the note proceeds were expected to partially fund repurchases.
- Purchase commitments totaled $927.2 million, primarily for data-center hosting; this includes a five-year cloud-services agreement with a $300 million total commitment. Future minimum operating lease payments were $125.4 million, plus $49.5 million for leases not yet commenced.
- Unity recorded $5.6 million in Q2 restructuring charges. The prior-year quarter included a $49.8 million one-time lease-termination expense and $10.5 million of incremental equity-award modification expense related to the former CFO’s separation, which helped explain lower year-over-year G&A expense.
- Two putative class actions were disclosed: a July 2022 securities suit alleging misleading statements and omissions regarding platform issues and fiscal 2022 guidance, and an August 2022 stockholder suit concerning disclosures for the ironSource transaction. Unity said it believed the claims were without merit and intended to defend them.
Most important facts for investors to verify
- Whether remediation of the Operate Solutions data-quality and monetization-tool issues restores performance, and whether management’s recovery timeline through at least Q4 is achieved.
- Whether Create Solutions growth can offset continued weakness in Operate Solutions, and how expansion rate and large-customer growth trend in subsequent filings.
- How much of the six-month cash-flow improvement is recurring versus attributable to the Weta FX license-fee prepayment and working-capital timing.
- The ironSource transaction’s closing, final consideration and dilution, and the terms and funding of the contingent notes and proposed repurchases.
- How ongoing losses, stock-based compensation, hosting commitments, and the 2026 convertible notes affect cash needs and progress toward profitability.
- Developments in the disclosed lawsuits and in privacy-platform policy changes, macroeconomic conditions, and foreign-exchange impacts on Operate Solutions.