Unity Software Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022. Unity provides software to create, operate, and monetize interactive 2D and 3D content. Financial amounts below are in U.S. dollars; “million” and “billion” are used for readability.
Financial performance
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Revenue | $320.1 million | $234.8 million | +36% |
| Gross profit / margin | $226.3 million / 71% | $176.0 million / 75% | Margin down 4 percentage points |
| Operating expenses | $397.5 million | $286.9 million | +38% |
| Operating loss | $171.2 million | $110.9 million | Loss increased |
| Net loss | $177.6 million | $107.5 million | Loss increased |
| GAAP diluted loss per share | $0.60 | $0.39 | Loss per share increased |
| Operating cash flow | $101.3 million | $(88.9) million | Improved |
| Free cash flow (non-GAAP) | $86.4 million | $(100.6) million | Improved |
Create Solutions revenue was $116.4 million, up 65%; Operate Solutions revenue was $184.0 million, up 26%; Strategic Partnerships and Other revenue was $19.7 million, up 11%. Growth was attributed substantially to existing customers: Create growth reflected new and expanding customers, while Operate growth largely reflected greater customer consumption.
Non-GAAP gross margin was 76%, versus 78% a year earlier. Non-GAAP operating loss was $23.0 million, compared with $23.4 million; non-GAAP net loss was $25.4 million, or $0.08 per share, compared with $27.3 million, or $0.10 per share. These measures exclude, among other items, stock-based compensation and acquired-intangible amortization.
Liquidity, debt, and balance sheet
- Cash, cash equivalents, and marketable securities totaled approximately $1.81 billion at March 31, 2022, including $1.15 billion of cash and cash equivalents and $656.6 million of marketable securities.
- Operating cash flow included a $189.4 million increase in deferred revenue. Management said it was primarily driven by receipt of four years of license fees connected to the Weta Digital asset acquisition; it was partly offset by the annual bonus payment, net loss, software-license prepayments, and working-capital needs.
- Investing cash outflow was $35.5 million, including acquisitions and capital expenditures; financing cash inflow was $30.2 million, solely from employee equity-plan share issuances.
- Unity had $1.725 billion principal amount of 0% convertible senior notes due 2026, carried at $1.704 billion net of issuance costs. The notes were not eligible for holder conversion at quarter-end. The filing identifies $2.52 billion of contractual obligations, including the notes, leases, and purchase commitments, most of the latter related to cloud hosting.
- Management stated existing liquidity should cover working capital and capital expenditures for at least the next 12 months, while noting that longer-term needs may depend on operating cash flow and possible future financing.
Material changes and management commentary
- Unity reported temporary Operate product challenges in February and March, including reduced product efficacy following ingestion of bad data from a large customer. Management estimated an approximately $110 million impact on 2022 business, expected the effects to persist through Q3 and be minimal in Q4, and said it expected no carryover impact in 2023. Management characterized the issue as temporary, not structural.
- Gross margin fell as cost of revenue rose 60%, faster than revenue. The filing cites increased personnel costs, acquired-intangible amortization, and hosting costs. Research and development increased 44% and sales and marketing increased 49%, reflecting higher staffing and investment; sales and marketing also included increased travel and conference spending as COVID-19 restrictions eased.
- Stock-based compensation expense was $103.4 million, up from $66.6 million. Depreciation and amortization was $41.5 million, versus $11.8 million, including higher acquired-intangible amortization.
- Customers generating more than $100,000 of trailing-12-month revenue increased to 1,083 from 837. Dollar-based net expansion rate was 135%, down from 140%.
- MindKick was acquired in January for approximately $46.6 million of total consideration, including cash, shares, and the fair value of Unity’s previously held interest. Its revenue and earnings were not material to consolidated results.
Outlook, risks, and contingencies
The filing provides no formal quarterly or full-year revenue or earnings guidance. Management expected continued operating losses for the foreseeable future as it invests in research and development, sales and marketing, and administration. It also expected gross profit to rise in absolute dollars but gross margin to fluctuate.
Key risks include reliance on Operate Solutions and gaming customers; the impact of platform and privacy-policy changes, including Apple’s tracking opt-in requirements, on advertising monetization; competition and customer retention; product reliability and data quality; dependence on third-party cloud hosting; and evolving privacy, data-security, and children’s-protection rules. Unity also cited macroeconomic and geopolitical uncertainty, including the Russia-Ukraine conflict and U.S.-China risks, as potential business risks.
Unity reported no material pending legal proceedings and said it was not aware of circumstances creating a material indemnification liability. It disclosed $121.8 million of gross unrecognized tax benefits; up to $1.8 million could decrease within 12 months due to expiring statutes of limitations. The filing also noted a prior voluntary export-control and sanctions disclosure that regulators closed in 2021 with cautionary and warning letters and no monetary penalties.
Important facts for investors to verify
- Whether the Operate product and data-quality issues resolve on the timeline management expected, and whether the estimated 2022 impact remains approximately $110 million.
- How much reported operating cash flow and free cash flow depended on the one-time, multi-year Weta-related license-fee prepayment, and whether cash generation improves on a recurring basis.
- Whether revenue growth, particularly in Operate Solutions, can offset higher operating costs and the decline in GAAP gross margin.
- The scale and persistence of stock-based compensation, acquired-intangible amortization, and other exclusions in Unity’s non-GAAP results.
- How Apple and other platform privacy changes affect advertising effectiveness, customer consumption, and Operate revenue.
- Liquidity and refinancing or settlement implications of the 2026 convertible notes, cloud-hosting commitments, and future investment needs.