Unity Software Inc. — Q3 2020 Form 10-Q
Business context and period. Unaudited results for the three and nine months ended September 30, 2020, compared with the same 2019 periods. Unity provides software to create, operate and monetize interactive 2D and 3D content. Its Create Solutions serve content developers; Operate Solutions include advertising monetization, cloud services and hosting. Unity reported approximately 2.5 billion monthly active end users and more than five billion monthly application downloads during the first nine months of 2020. The company completed its IPO in September 2020.
Financial performance
Amounts below are in USD millions except per-share data and percentages.
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $200.8 | $130.9 | $552.1 | $383.7 |
| Gross profit / margin | $153.2 / 76% | $104.5 / 80% | $432.3 / 78% | $295.1 / 77% |
| Operating loss | $(141.7) | $(41.7) | $(194.0) | $(102.1) |
| Net loss | $(144.7) | $(45.5) | $(198.8) | $(112.6) |
| Basic and diluted loss per share | $(0.97) | $(0.76) | $(1.47) | $(1.39) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $5.1 | $(68.8) |
| Free cash flow (non-GAAP) | Not provided for quarter | Not provided for quarter | $(23.8) | $(85.3) |
Revenue, costs and material changes
- Q3 revenue rose 53% year over year. Create Solutions revenue increased 45% to $62.6 million; Operate Solutions increased 72% to $120.0 million; Strategic Partnerships and Other was essentially flat at $18.2 million. For the first nine months, revenue grew 44%: Create +36%, Operate +63%, and Strategic Partnerships and Other -10%.
- Management attributed growth chiefly to expansion and greater usage among existing customers. Operate Solutions benefited in part from elevated engagement during COVID-19 shelter-in-place measures. Create Solutions also benefited from the Finger Food acquisition, while pandemic-related sales-cycle delays and partner offering retirements weighed on results.
- Q3 GAAP gross margin declined four percentage points, to 76%, mainly reflecting higher hosting costs and professional-services growth. Operating expenses rose 102% to $294.9 million, including a $63.6 million non-cash charitable stock donation and increased stock-based compensation following the IPO. Q3 stock-based compensation was $61.8 million, versus $9.1 million a year earlier.
- Q3 non-GAAP operating loss was $8.4 million versus $27.8 million in Q3 2019; non-GAAP net loss was $13.0 million versus $35.2 million. These measures exclude, among other items, stock compensation and the charitable contribution and should not be viewed as substitutes for GAAP results.
Financial position and liquidity
- At September 30, cash was $1.759 billion, restricted cash $22.4 million, total assets $2.606 billion, and stockholders’ equity $2.060 billion. Accumulated deficit was $714.0 million.
- The $125 million revolving credit facility drawn in March was repaid in September; no borrowings were outstanding at quarter-end. The facility matures in 2024, and the filing states the full $125 million was available. The agreement includes a $75 million minimum-liquidity covenant; Unity reported compliance at quarter-end.
- Nine-month investing cash outflow was $64.7 million, including $35.0 million of acquisitions and $29.0 million of property and equipment purchases. Financing cash inflow was $1.694 billion, principally reflecting IPO proceeds and other equity issuances.
- Operating lease liabilities totaled $126.2 million. In addition, $154.1 million of future minimum payments related to leases not yet commenced were not reflected on the balance sheet. Unity also disclosed $25.2 million of future minimum commitments under new vendor agreements and a six-year cloud-services agreement with $203.5 million of aggregate minimum commitments over its term.
- In October 2020, after quarter-end, Unity invested $1.470 billion in marketable securities. Management said existing cash was expected to cover working capital and capital expenditures for at least 12 months, while anticipating continued operating losses and negative operating cash flows for the foreseeable future.
Outlook, risks and unusual items
- The filing gives no specific numerical revenue or earnings guidance. Management expected Q4 2020 free cash flow to be negative and did not expect the usual Q4 seasonal increase in Operate Solutions, because it believed the related engagement increase had occurred in Q2 and Q3. Management also expected free cash flow to remain volatile.
- Apple’s announced iOS changes to tracking consent and advertising identifiers could adversely affect monetization revenue; timing, implementation and financial impact were uncertain. Unity also cautioned that COVID-related Operate demand could moderate, while customers and partners might delay spending, seek concessions or face financial distress.
- Other significant risks include continued losses and uncertain path to profitability; dependence on Operate Solutions and gaming customers; competition; reliance on third-party platforms and cloud infrastructure; privacy, data-security and children’s privacy regulation; international and China-related risks; and execution risks in expanding beyond gaming.
- Unity disclosed August 2020 voluntary self-disclosures to OFAC and the U.S. Department of Commerce’s Bureau of Industry and Security regarding apparent export-control and sanctions violations. Potential outcomes were not specified. The filing also describes two related putative end-user privacy class actions and an employment lawsuit compelled to arbitration; it reports no material pending legal proceeding in the legal-proceedings item.
- The quarter included the $63.6 million charitable stock donation and a cumulative $49.6 million stock-compensation charge for previously outstanding RSUs when the IPO satisfied their liquidity-event vesting condition. The IPO generated approximately $1.418 billion of net proceeds; convertible preferred stock converted into common stock.
Important facts for investors to verify
- Whether Operate Solutions growth and elevated user engagement persist as pandemic effects and seasonal patterns change, and how Apple’s privacy changes affect advertising monetization.
- Whether revenue growth can translate into improving GAAP margins and a path to profitability, given rising operating costs and substantial stock-based compensation.
- Cash generation excluding significant non-cash items, including stock compensation and the charitable donation, and the use and returns of the post-quarter-end marketable-securities portfolio.
- Exposure to lease, cloud-hosting and other contractual commitments, including leases not yet commenced and the cloud-services minimum commitment.
- Developments and potential financial consequences from the export-control self-disclosures, privacy litigation, and evolving privacy and data-transfer requirements.