Unity (Minutes): Kickoff Meeting for the New Model

The following $Unity Software(U.US) is the minutes of the Q4 2024 earnings call. For the earnings report interpretation, please refer to《 Has Applovin Pressed Too Long? Unity Hasn't Started to Party Yet! 》

1. Core Financial Information Review

1. Revenue Situation: Strategic portfolio revenue was $442 million, a year-on-year increase of 4%, exceeding the upper limit of guidance by $15 million. Among them, Create Solution's revenue was $139 million, a year-on-year increase of 9% and a quarter-on-quarter increase of 6%, benefiting from a 15% growth in subscription revenue, with non-gaming industry revenue accelerating by 50%;

Grow solutions revenue was $303 million, a year-on-year increase of 2% and a quarter-on-quarter increase of 2%.

Revenue from the non-strategic portfolio was $15 million, a year-on-year decrease of 92% (due to the divestiture and adjustment of key businesses), expected to reach $30 million for the full year of 2025 and remain stable. In the future, the company will report and guide total revenue, providing total revenue data for Create and Grow businesses separately.

This is the best quarter we have seen in the past year, with robust performance attributed to a combination of better execution and seasonal demand. Supporting the strong revenue results is Unity's quarter-on-quarter improvement in dollar-based net expansion, with the net expansion rate increasing by 2% to 96%, and the number of customers exceeding $100,000 also increasing to 1,254 customers.

2. Profitability Indicators: Adjusted EBITDA for this quarter was $106 million, with a margin of 23%, exceeding the upper limit of guidance at 26%; for the full year, it was $390 million, with a margin of 21%, benefiting from improved platform gross margin, operational leverage, and cost management. Adjusted gross margin increased from 82% in 2023 to 83% in 2024.

3. Expense Situation: Adjusted general and administrative, sales and marketing, and R&D expenses for 2024 decreased by $235 million.

4. Free Cash Flow: In the fourth quarter, it was $106 million, a year-on-year increase of 74%; for the full year, it was $286 million, a year-on-year increase of 60%.

5. Asset and Liability Situation: Cash at the end of the quarter was $1.5 billion, with liabilities of $2.2 billion. The company used free cash flow to repurchase $415 million in debt, with opportunities to gradually deleverage in the coming years and continue to optimize dilution management strategies6. Equity-related data: The dilution of shares caused by stock compensation is expected to decrease from slightly below 3% in 2023 to slightly below 2% in 2024. It is anticipated that stock compensation expenses will decrease by 30% in 2025, and the dilution management strategy will continue to be optimized.

7. Guidance for the next quarter: Total revenue for the first quarter is expected to be between $405 million and $415 million, with adjusted EBITDA between $60 million and $65 million. Revenue guidance takes into account the reduction in existing advertising model revenue, the transition to Unity Vector, seasonal demand, and differences in working days; adjusted EBITDA guidance considers revenue expectations, increased wage-related expenses, and additional cloud costs associated with Unity Vector investments.

II. Detailed content of the earnings call

2.1 Key information from executive statements

Business transformation progress: Fourth-quarter performance significantly exceeded revenue and adjusted EBITDA guidance, with rapid growth in strategic portfolio revenue and adjusted EBITDA exceeding the upper limit of guidance by 26%, reflecting the company's regained competitiveness.

Advertising business: The company announced the migration of the Unity advertising network to the new AI platform Unity Vector, which will begin at the end of the first quarter. The first phase of work is expected to be completed by the end of the second quarter of 2025, after which scaling and product quality improvements will continue.

Vector utilizes data from the Unity ecosystem and self-learning AI models to optimize performance, enhance targeting accuracy, expand audience size, and adapt to market changes in real time, but the business is iterative and will not immediately generate revenue in the early stages.

Create game engine: Customers have responded positively to the removal of runtime fees and the release of Unity 6, with rapid growth in new deals and renewals. Subscription revenue in the fourth quarter increased by 15% year-over-year. Unity 6 has seen high trial usage, with nearly 38% of existing users having completed the upgrade, and downloads reaching 2.8 million since its release. In 2024, Unity maintain its position as the world's leading game engine, supporting the development of numerous successful games across multiple platforms, with approximately 70% of the top 1000 mobile games and 30% of the top 1000 PC games made with Unity. It also leads in mixed reality and spatial computing, with "Batman: Arkham Asylum," made with Unity, exclusively released on Meta Quest 3 in October and winning Best AR/VR Game at the 2024 Game Awards.

Seven of the top 10 AR games in 2024 were made with Unity, and a partnership with Google has strengthened its industry position. Additionally, Unity's applications in markets outside of gaming, such as automotive and retail, are accelerating, with revenue growth of 50% in industry segments, making it the fastest-growing subscription business, and acquiring significant new clients like Toyota and Raytheon.

Technology and innovation Unity Vector: The company is building a new AI-driven advertising platform aimed at enhancing advertising effectiveness through more precise user matching and real-time data processing. This platform is expected to gradually launch in 2025 and significantly enhance the competitiveness of the advertising business in the long termThe company emphasizes the scalability and flexibility of its platform, which can integrate various 3D assets and support a wide range of applications from gaming to real-time services.

Market and Competition: Despite facing competition from Microsoft and other AI tools, Unity continues to maintain its leading position in game development and real-time 3D content creation with its strong platform and ecosystem. The company has established partnerships with large enterprises such as Google, further consolidating its position in emerging technologies like XR.

2.2 Q&A

Q: Of the quarterly decline of approximately $40 million to $50 million, how much is due to a decrease in Strategic portfolio revenue? I believe it is $15 million in the fourth quarter; how much of this is driven by the gradual reduction in growth of traditional advertising products? Has the new advertising model brought in incremental revenue?

A: This quarter's revenue declined by $40 million to $50 million sequentially, mainly due to our cautious approach towards revenue enhancement pilots resulting from business transformation. The business transformation involves large-scale product launches, and the large-scale operation of the new model takes time to take root, which is the main driver of the revenue decline. Non-strategic revenue in the fourth quarter was $15 million, and it is expected to continue, while the transformation of the advertising business is the main reason for the cautious conservatism.

Q: What are the drivers of subscription growth in the Create business? Are there other favorable pricing factors? What factors contributed to achieving a 15% growth despite the price increase announced in September not yet taking effect?

A: The Create business subscriptions achieved a 15% growth and were not affected by the price increase announced in September. The main drivers of growth are firstly the gradual realization of the impact from the previous round of price increases; secondly, re-establishing connections with customers has brought more trading opportunities. Previously, communication with customers was stagnant due to expectations of price increases and issues related to Unity 6 upgrades, but now positive business exchanges have resumed.

Q: How does the migration to Unity 6 compare to initial expectations?

A: 38% of users have migrated to Unity 6, and the migration is better than previous model updates. A more user-friendly pricing strategy was adopted when launching Unity 6 while emphasizing core values such as stability, performance, and ease of upgrade. This information has received positive feedback from customers, and large real-time clients may use Unity 6 for the long term, making this migration significant for the company.

Q: I heard that Microsoft launched its video game development product yesterday, and OpenAI hinted at future use in game creation. How do you respond to this challenge and ensure Unity remains at the forefront of innovation and market leadership, especially with Unity 6 and future versions?

A: Unity, as a platform, has its greatest advantage in scalability, becoming the assembly point for building interactive experiences and deep systems around 3D assets. Although there are new developments in the market, such as Microsoft's launch of video game development services and OpenAI proposing AI tools for game creation, building large-scale real-time service games requires not only creating assets but also developing deep online systems and optimizing systems. Unity hopes to be the platform for creating these systems and integrating various assets**

Q: What is the expected timeline from now until the new product launch? What are the key personnel specifically doing?

A: We have been building the Unity Vector system for the past two quarters, and last quarter we began testing it on real-time data, making rapid progress. By the end of this quarter, we will start the full migration to the new system, with the first phase of work completed by the end of the second quarter. This is an iterative process, and we will continue to build, expand, and optimize the system.

The system is based on improving three core attributes, or at least we should start to feel the impact of real-time adaptive self-learning in the most sensitive models across these three areas.

(1) The first is better conversion. Therefore, we can more accurately predict the ideas of new games that players want to play.

(2) Secondly, it is important, but crucially, we want to be able to match the most valuable players with the right games.

(3) Finally, we want to enhance our bidding capabilities.

Thus, these are the three core technologies we have been researching in the system, which will truly improve the ROI we deliver to our customers.

Q: Can the improvement in conversion rate be understood as the revenue from user acquisition tools and demand-side platforms (DSP) being relatively small in today's Grow solutions? What is the core improvement direction of the Vector system?

A: No, we provide user acquisition services, but our original competitiveness was not strong enough. This business has improved, and we expect this segment to gradually expand. The new system mainly focuses on three core attributes: first, improving conversion rates to more accurately predict new games that players might like; second, matching the most valuable players with the right games; and third, enhancing the ability to bid effectively in competitive auctions, which is expected to improve the return on investment for our customers.

Q: What is the outlook for pipeline development business in 2025? How is the competitive situation in the industry when dealing with large companies like Toyota?

A: The revenue growth of the commercial engine in the subscription business outside the gaming industry is the fastest, with a year-on-year growth of 50% in the fourth quarter, and this growth trend is expected to continue. This business focuses on 3D visualization and creating interactive experiences around it, with a strong emphasis on sectors such as automotive, retail, and manufacturing, achieving good results. Currently, few products in the market can provide similar value, and the company plans to improve the transaction scale and efficiency of the business by strengthening cooperation with dealers and large system integrators. In the past, the company's business mostly attracted customers rather than doing a lot of hard selling; that is, customers would proactively adopt the tools and then establish contact with the company. However, in the future, we will supplement more effective promotion mechanisms to better promote the business and expand market share through expanding partnerships.

Q: How much foundational R&D work has already been invested in Vector relative to the incremental investments expected in 2025?

A: Most of the foundational R&D work for Vector has been completed, and future investments will mainly focus on the cloud area for the continuous training of expanding models. Over time, this investment will become more efficient, and compared to the old models, the new models have advantages in cost control the past few quarters, the cost of goods sold and research and development costs have increased by approximately $10 million each quarter. While the company is promoting margin improvement, it is also making necessary investments in Vector.

Q: Matt, you have been very candid about the competitive challenges regarding growth. So I want to ask, how is Vector addressing the shortcomings in the machine learning (ML) tech stack and data infrastructure? Additionally, how should we view the changes and role of the ironSource network in the transition of the entire advertising platform to Vector?

A: We are currently conducting a performance comparison between the new and old models, but the results have not yet been publicly disclosed. The company's goal is for the new model to surpass the old model in the long term. The launch of Vector is expected to put the company in a more advantageous position in the competition, with anticipated benefits such as revenue growth, operational leverage improvement, and margin expansion as the business grows. The migration to Vector will first address iOS traffic, followed by Android traffic. The focus of the first phase is to optimize the conversion model to improve conversion rates; the second phase will gradually involve user value matching and optimizing bidding models, helping the company bid more effectively in player competition auctions, with the entire process being gradually advanced.

Q: Are there opportunities to better integrate data sources into the advertising stack? How much improvement has Vector made in integrating Unity's existing additional data? How does this differ from the previous model? Additionally, looking at some of your competitors, they have already expanded their game advertising business into other industry sectors. Can you talk about this broader opportunity? For example, e-commerce.

A: Data integration opportunities and plans: The Unity platform has nearly 5 billion global daily active players and has deep insights into player behavior, which is a unique asset. The company is working to integrate this data in a privacy-compliant manner, incorporating more data into the model by obtaining necessary user consent to enhance advertising effectiveness.

Cross-industry advertising opportunities: The company is optimistic about the opportunities for the advertising business to expand into other verticals such as e-commerce. Given the broad demographic of gamers, the company has a deep understanding of consumer behavior and a solid system, and these advantages will create value across different industries and types of advertising. In the short term, the company is primarily focused on the gaming vertical to improve service to core customers, but in the long term, it is confident about cross-industry expansion.

Q: Regarding the trend of margin improvement in 2025 and beyond? You mentioned the increase in cloud costs brought about by the Vector model reconstruction; can you provide specific figures? What are the estimated marketing costs after the launch of Vector? If Vector's revenue begins to grow in the coming years, will there be the high marginal profit margins commonly seen in the digital advertising market?

A: The company has done well in improving margins and ensuring a reasonable cost structure, with EBITDA margin increasing by 1% year-over-year, showing excellent performance in reducing general and administrative expenses (G&A) and improving gross margins.

In the past few quarters, while making necessary investments related to Vector, we have also been promoting margin improvement. In the past few quarters, the cost of sales and research and development, which includes significant cloud costs, has increased by approximately $10 million each quarter.** This is a business with an adjusted gross margin exceeding 80%. Our business model has significant leverage and operational leverage. As the business grows and accelerates, expanding profit margins will become easier.

We will benefit from revenue growth, operational leverage, and margin expansion from Vector. Currently, the immediate priority is to make necessary investments in Vector to restore it to a satisfactory revenue growth rate, but we believe these investments can be made while driving margin expansion.

Q: How should we strategically think about the migration of Vector in the second quarter? Will some advertisers see results at the beginning of the quarter, with a gradual rollout by region, or will all advertisers see improvements in conversion rates, user matching, and bidding efficiency throughout the entire quarter at the beginning of the second quarter?

A: The integration work will first handle iOS traffic, followed by Android traffic, in two steps. The first part of the work focuses on optimizing the conversion model to improve conversion rates; the second part will, over time, focus on user value, matching the most valuable players with suitable games, optimizing the bidding model, and effectively bidding in player competition auctions, developing in a step-by-step manner.

Q: What is the reason for advancing the launch of Vector from mid-year to the end of the first quarter? In the first quarter's performance guidance, how much is considered in terms of the disruption to business growth from the migration, and how much is influenced by seasonal factors?

A: The launch work has progressed faster and more efficiently than expected, so it started about a quarter earlier than anticipated. The performance guidance for the first quarter takes into account that the existing advertising business will experience some disruption during the transition from the old model to the new model.

Q: Can you share the performance comparison between the new model and the old model across different game types, regions, or devices?

A: Relevant work is ongoing and will not be disclosed externally at this time. However, the overall goal is for the new model to surpass the old model over time.

Q: During the integration of Jiang ironSource, Tapjoy, and Unity ads into Vector, is there a situation where some clients do not fully migrate their budgets? Is there currently any evidence that the migration rate will be less than 100% or that there will be business pauses?

A: The workaround Unity Vector is mainly conducted on the Unity advertising alliance network, and we are optimistic about the opportunities for subsequent integration of the ironSource advertising network and will actively promote that network. During the migration process, the company will integrate data from multiple assets (including Tapjoy, etc.), consolidating the data of these assets, which were previously operated as independent vertical businesses, into a central data source. We believe this approach can enhance the performance of all products, but this does not equate to merging these products into a single product.

Q: Does the migration from Plus to Pro in the fourth quarter have a positive impact on the business? Can you provide some directional comments on the organic growth and development trajectory of the non-game engine business in 2025, and how does the former contribute?

A: The migration from Plus to Pro has a positive impact on industry business, enhancing the speed of business development, while also positively contributing to re-establishing relationships with customers and increasing positive interactions with them. These three trends will continue in 2025.

In addition, subscription price increases will continue to be implemented in 2025 - 2026.

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