Unity Software - Q2 2023

Transcript

Richard Davis (VP of Investor Relations)

Welcome to Unity's second quarter 2023 earnings call. After the close of the market today, we issued our shareholders letter. That material is now available on our investor website at investors.unity.com. Today, I'm joined by John Riccitiello, our CEO, President, and Chairman, and by Luis Visoso, our CFO. Before we begin, I want to note that today's discussion contains forward-looking statements, including statements about goals, business outlook, industry trends, market opportunities, expectations for future financial performance, and similar items, all of which are subject to risks, uncertainties, and assumptions. You can find more information about these risks and uncertainties in the Risk Factors section of our filings at sec.gov. Actual results may differ, and we take no obligation to revise or update any forward-looking statements.

As in prior quarters, we will be providing both GAAP and non-GAAP financial measures. Unless otherwise noted, we will be speaking to the non-GAAP financial measures when describing our results. The shareholder letter and our filings on sec.gov include full GAAP to non-GAAP reconciliations. Okay, thank you very much. As we did last time, let's start off with two brief questions before we open up to regular Q&A. For John, you know, you've seen a lot of trends and cycles over your career. What are you kind of most excited about when you think about where Unity is today and where we're headed?

John Riccitiello (CEO, President, and Chairman)

Well, first off, I want to congratulate my colleagues on delivering strong execution and a great quarter in our second fiscal quarter. Really appreciate it. Great work. Congratulations! You know, when I look at Unity today, I really feel fantastic about the company and where it's heading, and there's a number of factors that make me feel great about Unity, both near term, but really importantly, long-term, for revenue growth and profit growth in a way that's super healthy and, I believe will deliver in huge ways for our customers and our shareholders. First, you've heard about Unity PolySpatial. It was great to be on stage with Apple at WWDC.

Since then, we've seen substantial interest from our developers in the PolySpatial Platform, and I think it represents another reason for developers to look to Unity to be the go-to platform for all real-time 3D development. We cover the platforms better than anybody, anyone, and we cover them spectacularly well with new platforms as they come out, and a great example of that is what Apple just announced just recently. The second is the Unity Cloud. We put that in market, in a closed beta recently. Expect to go general availability later this year. This is a platform that connects all of our services to our product.

If you want to think about this in a, in a way, the go-to-market motion just collapsed from people getting in a plane, taking a cab or an Uber, knocking on a door, to a click inside the editor. We like that. It makes it easy, makes it simple. We think it's going to drive increased adoption, and for us, this is substantial. It's going to lead to increases in consumption and ratable revenue in addition to subscription. The artist seats and usage and all that goes with that. You've seen lots of announcements from us recently on Wētā, Ziva, SpeedTree. We expect that's going to continue and drive increased artists, picking up the number of artists picking up our platform. Again, net new revenue, net new SaaS revenue, net new consumption revenue. Digital twins acceleration. Now, this is really important.

I hope you'll listen carefully. We're getting great traction in the market, and we're now focused on delivering repeatable solutions, high-margin solutions that deliver ratable revenue streams and consumption revenue streams. We have made a decision to de-emphasize our growth on the professional services side, a lower-margin business, and we're really thrilled to be able to rely on partners like Capgemini and Booz. This is a great move for Unity. It adds significantly over time to our, our, our bottom line. A little bit less professional services growth, but it's a good strategic trade for the margin and for the business on a strategy perspective for how we're going to build our position in the marketplace. One platform, this is the synergy story. This is why Unity Create and Unity Grow are together in a way that delivers better for our customers and better for our investors.

Here, we're getting deep integration between advertising, mediation, publishing, UA tools inside the editor. We're working through some really important incremental synergy programs, and we'll be sharing more about that later in the year. You should start thinking about with all the synergy we're already getting, there's more to come, and there's an advantage in being the place where our customers build their product and monetize their product. I couldn't be more excited about the two AI products that we announced some weeks ago. A huge amount of interest from our customers, we're there on the creation side and the operation side for applications with Muse and Sentis. We'll be looking at a business model for these as much like what Microsoft has announced with some of their AI products. Again, incremental revenue around SaaS and incremental revenue around consumption.

Here we have a particularly specific set of opportunities because people forget that Unity has a large number of free users. Well, these users are going to want to use AI, because it will significantly expand their ability to build what they have in their mind's eye, to get it on the screen, to get it in the hands of their customers. We're super excited about that. The handful of reasons, all product innovation driven, that'll put us in a great position for growth, both on top and bottom line.

Richard Davis (VP of Investor Relations)

Great. Thank you very much. Luis, you know, we're at the halfway point in 2023, so it'd be kind of great to highlight, you know, how things have played out in those first six months and, you know, as we kind of look forward to the rest of the year.

Luis Visoso (CFO)

Yeah. Thank you, Richard. We are actually very happy with our results. If you look at it, I'm sure everybody's read our shareholder letter, we had a record quarter. We were ahead of expectations, as John just mentioned, we're bringing a ton of innovation to the market, which we believe will position us well into the future. We're very happy overall. Just to go a little bit deeper, what we've committed and talked to several of you is about creating shareholder value by driving three things. One is revenue growth, expanding margins, and efficient use of cash. If I touch on each of them, on revenue growth, we accelerated growth to 11% this quarter, great improvement quarter-over-quarter, we're winning with customers in games and in industries.

Frankly, I would say this is still in what I would call a challenging economic environment. You know, some of our game customers are not adding headcount. Some of our sales cycles in industries are still a little bit longer as we need to prove value. China Create market continues to be soft overall, and the ad industry has been relatively stable, with not much seasonality so far this year. Very importantly, we're winning in this environment, and we estimate that we're growing faster than the markets in which we compete. Overall, on revenue side, we feel pretty good, but that's not it, right? We deliver all this acceleration while significantly improving our profitability, with strong progress on a GAAP and non-GAAP basis. EBITDA was $99 million.

You know, we needed to get a few hundred thousand more to get to 100, but we're very close to rounding to that magic number. 18.5% margin is a good place to be, particularly when we look at where we were just four quarters ago. In Q2 of last year, we were -13%, so from -13% to almost 19% just in a year. That's driven by choices we've made. You know, there are portfolio choices we've talked about before. We've reduced hierarchy, we're driving cloud efficiencies, we're reducing our office footprint, just a lot of decisions we've made to really make us a sustainable and profitable company. As John mentioned, we're reducing our reliance on professional services as we build that scale to be a profitable business.

Third, on cash flow, we are now positive. You know, we delivered $33 million in the quarter, but more importantly, we're now where we believe to be sustainably on the positive side on the cash generation. You know, obviously, there will be normal quarterly fluctuations based on payment schedules and those type of things, but we're clearly now on the positive side. With all of this, I'm actually, you know, very optimistic about the year. If you look at where we guided at the beginning of the year for the midpoint of our revenue guide for the full year, that number was $2.125 billion. Last quarter, we added another $15 million to the midpoint of our guidance range, and now we're adding another $20 million. We're now guiding the midpoint of our revenue guide at $2.16 billion, right?

We're making progress. We're feeling more confident about where we are in the whole year, and that's encouraging. Before I turn it back to you, let me just talk a little bit about Create and Grow. On Create, one key number is our core subscription growth, excluding China, 22%. That is a very healthy number. Our actions are working. Our price increase has been, is clearly flowing through, so we're very happy with our core subscription, excluding China. Industries, 30% of total Create, despite our reduction of our reliance on professional services, as John mentioned, and there is just a ton of innovation.

You know, if you look at the letter, industries SKU, Unity 2022 LTS, Unity PolySpatial, Unity Cloud, AI, pricing opportunities, and just a lot going on, which gives us confidence that we will be able to sustain this growth for, for the foreseeable future. Grow is, is just as exciting. You know, we're seeing some of the industry leaders, such as Supercell, Sega, joining LevelPlay. Now they are making the choice to move to LevelPlay because they, they, they believe that's a better play for them. Supersonic continues to do very well. We're adding new titles to our, to our portfolio. Remember, Supersonic has published some of the most downloaded games in the U.S. and key markets, so very, very strong performance there. We talk about AI within Create, but AI is also helping us on Grow.

You know, we are using AI and machine learning to strengthen our algorithms, to deliver better ROI for our customers. Frankly, I think we're just getting started. There is more to come, more synergies to come over the next few quarters and years. Overall, the integration between ironSource and Unity is going well. Richard, if I had to summarize an answer to a question, I would say we're very happy with where we started now in the year, and we look forward to a strong Q3 and Q4.

Richard Davis (VP of Investor Relations)

Great. Thank you very much. As we did last time, remember, we'll promote you to panelist, raise your virtual hand, and we will unmute you and call on you. Also, we'd ask that you unmute yourself and turn on your video, if possible. We'll do some Q&A for about 20 minutes here. At this point, we'll see who's in the queue, and we can pick on whoever wants to talk first and ask a question. Thomas, do we have our people here that wanna ask questions?

John Riccitiello (CEO, President, and Chairman)

Clark, go ahead.

Richard Davis (VP of Investor Relations)

There we go. Thank you, Clark.

Clark Lampen (Analyst)

Hey, guys. Good evening. I've got two, the first one is for John, the second one for Luis. John, I'm going to pull us back a little bit, and talk about AI. I guess, as we think about some of the, the tools that you announced intra-quarter being commercialized, are those ones that are designed for the lower end of the market that maybe doesn't monetize, as you were talking about a little bit earlier? I guess, as these tools start to permeate the market, how do you think about, you know, either potential growth in the developer community overall, or the volume and velocity of creation impacting the market and some of your existing customers? Luis, I just wanted to clarify, I guess, on, on cost-cutting trajectory.

Last quarter, we talked about, I think, half of the cost synergies or so you initially identified being realized. Would it be possible to give us a rough update of what's, you know, where we are today? Thank you.

John Riccitiello (CEO, President, and Chairman)

All right, thanks for the questions, and, let me try to address them. First off, on AI, we've introduced product on two sides of the ledger. On one side, it's to help people create content, and then the second aspect, that's called Muse. The second that we put out there is Sentis, which allows games and real-time applications to do things they've never wanted, never been possible before. Non-player characters in games could feel alive, almost like they're supporting their own ChatGPT interaction, but that can be physical, too. The way they move around and walk around or interact with one another and with players. It also is super relevant inside of digital twins, where, an agent inside of a digital twin can predict what's going to happen next or run scenarios or run simulation. We feel great about that.

That's ratable and consumption revenue, but that's actually not what you asked about, but I wanted to make sure I got that out there so you didn't think my focus on Muse was exclusive, and that's all we're doing. Muse on content creation. I think it does. It really addresses, in a way, three audiences. Now, what it allows you to do, by way of example, is, you know, you can use your finger to, if you've got a touch device as input, to draw something. It might look like, you know, anything from a bunny to a wagon to a car, and the engine can understand that and turn that into professional art. It could also be word prompts, like a large language model might digest or generative art tool might digest. It also might be code.

For our developers, again, we're training against Unity data, so when it produces code, it can generate the right kind of C# script that is right for use inside of Unity. No one else can train against that. Now, that's for the professional developer and for the second group we're going to talk about. This is going to make them more productive. In being more productive, and of course, they'll be using servers, it'll be some cost, but we're quite confident we can price above our costs on a consumption or a subscription basis. The key there is more revenue out of existing users. The second group of people out there are those that are small enough, and they're large in number, but small enough so that they qualify for our personal edition and/or edu users, and there's millions of them.

These users are presently using our Asset Store, and other digital assets online to sort of create content. It is a very hard thing to do, to find the assets or draw the assets or create them. I mean, what would you do if you wanted an environment with a river, maybe a stream coming off the side of it, a mountain, clouds, et cetera? That, that could take somebody weeks, if not months, to create in a real-time, 3D digital asset collection. Guess what? You can use the words I just used to describe that, and it will show up in your scene. Hugely valuable to them. So for these users, these, these customers that are not presently paying us, there's a reason to pay us, and it's a really important reason.

They may not want to pay us $10 or $20 or $30 or $50, whatever the amount of money is over a period of time, but it might be better than spending 2 months on something. It's a huge value for the value we can bring to them. The last group are those that are presently not using Unity because it's too complex. We get several thousand people per day that come to Unity, download it, look at the editor and say: "Wow, this looks like a, a 747, you know, control panel without autopilot." It is complicated. Real-time 3D is complicated. For them, where they need art assets or lighting assets or other things to advance into the game or scripts, they can just ask for them. It radically will simplify and bring new users onto the platform.

Do I expect an inflection point on new users just because of AI, like in December? No. I believe over time, we'll capture a much larger portion of the people that hit the top of the funnel for us and begin their journey on real-time 3D creation. For those of you who know the reference point, getting their own Unity logo tattooed on their elbow or somewhere else. We think this is a great invitation to the, the large mass of people that want to be creators, and up until now, that was a little bit beyond their count or capability.

Luis Visoso (CFO)

Hey, Clark, to the second part of your question, we've captured about two-thirds of the benefit in Q2, you should expect a little bit more to come.

Just keep in mind that we also had a merit increase and a few other things, so it's not as easy and straightforward to do the forecast. To answer your question directly, it's about two-thirds of the benefits are in Q2.

Richard Davis (VP of Investor Relations)

Great. Thanks. Okay, well, we have one of our newer analysts covering us. Brian Fitzgerald, we'll pop you in here.

Brian Fitzgerald (Analyst)

Thanks, guys. It looks like industry grew in line with broader create segments. Just curious about how you're defining industry. Can you only recently introduced an industry specific SKU, and whether that definition may change? A follow-on to that is any early read on the adoption of industry by online customers since its launch, or perhaps the use cases that those online customers may be looking at? You've spoken before about automotive, but we're curious if there are any new emerging use cases you're sorting out or beginning to see traction with.

John Riccitiello (CEO, President, and Chairman)

Okay. Let me step back a little bit, and, Luis, feel free to add on to what I'm talking about. In general, we generate revenue in digital twins from three activities. We generate it from professional services, engagements that enable a customer to get that real-time digital twin. This could be an airport or a city, a manufacturing facility, for high-end watches, or for automotive, or for any other number of things. It could be for a retailer. We're, we're seeing strong demand from all of the sectors I just mentioned. The first step for many of them is to get up and running on Unity, and for that, we often have a professional services engagement. The second component, is also now it's at scale as well, which is the seats that they consume.

Originally, they consumed the same professional or the proceeds that a game developer would use. What we've done with our industry SKU is married to that, all the tools or many of the tools that they would need for their specialized use cases, around, you know, changing, you know, file sizes and level of detail and stuff that are super important. Because somebody might, you know, wanna step down a 3 billion poly model into something that is a fifth that footprint, so it can be edited or moved or carried on something like a hard drive, smaller than a, you know, small pickup truck. That level of, of, of transformation is super important, but there's a number of other things that are certainly important to this customer base, that is not important or as important to game customers.

That's why it's a premium SKU with added value to it. The third, this is really more nascent for us, is ratable revenue once they've got their, their, their digital twin up and running, where they're using us for simulation, or they're using us for rendering, or they're using us for computer vision, where it's essentially a, a cloud model, hence the importance of the cloud platform that I mentioned earlier in the call today. Where we are right now is a situation where our largest revenue stream is professional services. Our next largest revenue stream is seats, and our third and more nascent, is ratable. The reason that we brought customer partners like Capgemini and Booz to the platform is our own professional services business, our own capacity on that front, is something that we did not want to increase.

In fact, we might want to decrease it a little bit and rely more on our own services for lighthouse customers, and once the model is proven, to partner with third-party system integrators like Booz and like Capgemini to scale more rapidly. That would result in less professional revenue service or professional services revenue, more seats, obviously, with more customers and more as they get to their operation, more ratable revenue streams. We've been transforming our business from a, a business model perspective, sort of under, you know, under the covers to make sure that we're scaling, makes a huge amount of sense for us longer term. Now, in terms of demand, frankly, we've been supply constrained, not, you know, pushing a lot for demand. It's the sectors that you know. We're very keen on government.

There's a lot of interest there, and I'll get into that if you want to. Another area where there's large interest is manufacturing, particularly the automotive industry, but also specialty manufacturers in the watch marketplace, which I've mentioned. There's a fair amount of interest on the retail side, there's a lot on architecture, engineering, and construction. What we're working to do between now and the end of the year is to bring it down more so to a handful of turnkey solutions that we can scale rapidly. We think that's the best way to scale this business into a very high margin, contribution to Unity, because it leads to the two high-margin businesses we like, which is SaaS revenue and consumption revenue. That's the evolution. You know, we always mention customers, as we did this time in our Shareholder Letter.

We typically don't go beyond the ones we list in our letter because a lot of these are work in progress, where their customers haven't given us the, their IR permission to reference them on a call until the product's delivered.

Brian Fitzgerald (Analyst)

Hey, Brian, just to add a few pieces, since you probably don't have all the background here. If you think about Create, we're splitting it in two when we talk to you. One is games and the rest is Industry. We used to call it non-games, but frankly, that's not a good name. Whenever we talk about Industry represents 30% of total Create, that's what we're talking about. Everything that has nothing to do with games, all the customers that John was just referring to. Just from a definition point of view, that's what industries refers to. The industry SKU is specifically designed for these customers, and as you saw in the letter, it's the fastest SKU ever, and very importantly, it's a little bit over two times the price of the games equivalent SKU.

Got it. Very helpful, guys. Thank you.

Luis Visoso (CFO)

Thanks, Brian.

John Riccitiello (CEO, President, and Chairman)

Thanks. I will go to Tim Nollen.

Tim Nollen (Analyst)

Great. Can you hear me?

John Riccitiello (CEO, President, and Chairman)

Yep.

Tim Nollen (Analyst)

There we go. Thanks very much. Two questions, both, I think, kind of clarification or a bit more color on some previous points you've made. John, I heard what you were explaining about, you know, the kind of shift away from professional toward more seats and more ratable services. A couple things in your slide deck were interesting. You talked about an AI Marketplace and about Unity Cloud, which you also referred to. I'm just wondering, how much are these, like, new significant upsell opportunities? i.e., can you charge incremental fees for these, the way I think you were saying you were looking to be able to charge more for AI services in your various businesses. Is it kind of like, you know, incremental charge points that you can add on to your subscription levels?

Another question for Luis would be, I, I heard what you're talking about, your comments around the Grow business. You had a pretty good swing from -7% in Q2 to +9% pro forma in Q3. Could you talk a bit more about where this is coming from? Is this volume or price or market share gains or growth, maybe perhaps beyond gaming into other industries? Thanks.

John Riccitiello (CEO, President, and Chairman)

On the AI side, what I've addressed so far is subscription plus ratable for the tools we make, Muse and Sentis. Muse will likely be more subscription, but also ratable, 'cause there obviously there'll be some volume level where we need to charge more. Sentis will be largely incremental, ratable revenues. The Marketplace, you know, we've got a fairly large number of partners here, I'm sure it's missed by no one on this call, that the market frenzy around new AI startups is spectacular. One of the things I find super interesting is they have a huge number of people that want to write them checks for 100 times the year after next year's revenue, and they don't have any customers, and...

which makes estimating the year after next year's revenue a little more challenging than it might otherwise be. Now, that's actually, obviously an exaggeration. A lot of our partners do have customers, but you understand my point. What Unity does with Marketplace is we take the universe, the by far the largest universe of real-time 3D creators, and connects them to the people that make AI tools, whether it be for creation or any other purpose. We're a huge believer in this idea. We think we've, we've got the right products in Muse and Sentis, but this augments us, augments that, and these are mostly rev share deals for us. If the, if the partner is working on a per-seat basis, then it's some share of that for a defined period of time.

These are typically negotiated, and my sense is that AI providers that are out there, they're going to move around a lot. What, we've had years of doing this with the App Store or the Asset Store, excuse me, where we, we generate a revenue share based on what transacts inside the store. We expect that'll continue longer term here.

Luis Visoso (CFO)

Yeah, I think, Tim, to your second question, first of all, Q1 of 2022 was huge, right? That's, that is still when eCPMs were very high and inflated, so, so we're comparing against a, a very high Q1 of last year when you look at that -9% for growth for Q1. I think the most important metric to look at is the quarter-over-quarter growth, which is about 13%. We're very happy with the improvement we're seeing quarter over quarter and therefore year-over-year with, with Q2. Where is that coming from? I think overall, the market, we're seeing good engagement, but eCPMs are lower than they were at their peaks, right? The flat market is good engagement, but a little bit lower eCPMs, and therefore, our growth is clearly ahead of the market.

Now, what we're seeing is as I said earlier, some customers migrate to LevelPlay, and, and that's driving our growth. So we believe we, based on our analysis, that we're growing faster than the market, more units in a, in a still tough eCPMs environment.

John Riccitiello (CEO, President, and Chairman)

You guys, for those of you that haven't been tracking our, our commentary on the ads as carefully, on the ad side as carefully, what Luis said was correct. As we entered, exited the COVID, the, the last boom quarter, was Q1, although Q2 last year was really strong as well. The market slowed down in the second half of last year, and our guidance for this year was based on the expectation that the market would level out based on trend lines we saw at the end of Q3 and Q4. That's been borne out. Although we've seen some modest oddities around seasonality, there wasn't as much positive seasonality when kids got out of school.

I think it's going to take a little bit of time for us to completely read the market, but we based our guidance on the market leveling out, basically being in a stasis mode for a period of time. We have all expectations that the market will turn north again on eCPMs. There's a lot of interest from developers for launching new products. That's usually what drives it. We based our full year on modest seasonality impact, particularly around the holidays, but stasis for the year, and that's proved to be approximately correct. Our growth in Q2 was very pleasing for us to see against the strong prior year comp, and the sequential growth was, you know, very good for us to see.

Richard Davis (VP of Investor Relations)

Thanks. We have a quick question from Dylan Becker.

Dylan Becker (Analyst)

Yep. Hey, hopefully, you guys can hear me. John, maybe another way to kind of ask the, the AI question, too, and as it pertains to kind of the idea of, of the tethering between Create and Operate, I wanted to focus on the Luna offering and maybe the importance of creative management automating kind of within the actual creation tool itself, and how AI can augment the capability to provide more tailored experiences and engagement for campaign management? Thanks.

John Riccitiello (CEO, President, and Chairman)

As you know, we don't break out Luna. It's a relatively small business. We are very pleased around a couple aspects strategically of Luna. For those of you who don't know, what Luna is, is this user acquisition platform that a developer can use not only to identify opportunities to build their business inside of gaming inventory, so other game ads, but also within social networks or within the App Stores and other ad opportunities, opportunities to see. What this tool does is it allows a developer to test creative against specific audiences in and outside of game inventory.

In, a way, it's sort of like a, a more strategic version of a DSP, except it-- what it aggregates is just one sector, game developers, but there are a few outside of gaming, but it's primarily game developers. Part of the business model is we get paid by the targeted media. By way of example, we are very much a, a favored partner of Apple, which makes us feel great to be a favored partner of Apple in, in this ecosystem. I didn't quite discern a question in, in, in what you brought up, so I'm just framing what the, what How this works and why we feel good about it. We've been successful to add new ad inventory over which we generate revenue share when people place through Luna, we feel very good about that.

The business model transformation that we've been introducing subtly was, you pay for Luna versus Luna basically pays for itself. We think that's a more scalable model that's been introduced, and it is working well for us. It's still relatively small, but it's got good trend lines. The other thing I would throw in there for you is you're 100% right on the notion of AI will facilitate more opportunity to create more diversity in the ad offerings, testing different types of ads over time. That will lead, I think, to more optimized, spend opportunities or UA opportunities for our customers, which is why we built it to begin with.

Richard Davis (VP of Investor Relations)

Great. We'll switch over to Brent Bracelin.

John Riccitiello (CEO, President, and Chairman)

Hey, Brent.

Brent Bracelin (Analyst)

Hey, how are you? Can you hear me okay?

John Riccitiello (CEO, President, and Chairman)

Yep, now we can.

Brent Bracelin (Analyst)

Okay, great. Hey, yeah, I really wanted to maybe start with Luis here. Obviously, Grow is really strong. $27 million sequential increases is certainly above normal seasonality for you. How much of that do you think is maybe an industry recovery, or, or are you seeing evidence of share gains?

Luis Visoso (CFO)

Yeah, I mean, I would say same as what I said earlier, I think we're growing faster than the market, we're seeing key customers move to LevelPlay, that's a great sign of our growth. We only have this ability to a portion of the market, obviously, right? What we see is encouraging and would point to market share gains. We can see Mediation, we can see LevelPlay, we're performing very strongly there, you know? One of the reasons is the AI efforts that we put in place, as I mentioned earlier, which are driving better return for our customers, investments. As I also said, that's just getting started. It will get better over time.

Brent Bracelin (Analyst)

Helpful color there.

John Riccitiello (CEO, President, and Chairman)

If you recall, when we did the acquisition or the merger with ironSource, we said that the combination of Unity and ironSource would lead to market share growth on combined, mediation, and that's a revenue growth for us. That's exactly what's happening.

Luis Visoso (CFO)

Totally.

Brent Bracelin (Analyst)

Yep. Maybe, John, for you, just, just double-clicking into large studios like Sega, leaning in and embracing LevelPlay. What, what's driving that? Can you maybe double-click on why the interest is picking up here? You talked a little bit about in-app bidding. I'm not sure if that's a, a material differentiator. What, what seems to be resonating on LevelPlay, where you're attracting some of the larger studios? Thanks.

John Riccitiello (CEO, President, and Chairman)

Well, look, I would say that there's a strategic argument, and then there's a lot of noise. To be perfectly frank, a lot of noise is there are incentives that go back and forth for people to move from one platform to another, and that is hard to discern, you know, which way that's going at any given moment in time. It's a competitive marketplace, where Unity is one of the leaders, but there are a few other players in the market that are also out there competing to win. What I think is driving the trend line towards Unity and the larger gains, it's a consequence of the fact that I think it's fairly obvious that Unity was a major player on the data side. ironSource was a major player on the data side.

The gap on Unity's data was no visibility on the Mediation component, which is a very important part. Where our advantage lived is we had a very strong ROAS tool set. We took two large data sets and pulled them together under one roof, which allows us to target users better, both in-app purchase spenders, which are very important, if you will, whales within the ecosystem of gaming, but developers very much want to target, but also those that are going to click through on ads and ultimately do installs, because the ad business is about generating not just installs, but high-value installs. I think our Marketplace, our, our customer base recognizes that strategic argument.

I'll admit, partly because we keep reminding them that that's the reason they should believe in us, but then we show them data and case studies, and they buy into it. We believe we're on a, on a long-term trend line that's favorable for Unity in this space.

Brent Bracelin (Analyst)

Helpful color. Thank you.

Richard Davis (VP of Investor Relations)

Great. Gili, at, at, Goldman Sachs? Hey.

Gili Naftalovich (Analyst)

Hey, guys. Thank you for, for taking my question, and congrats on the quarter. John, I think you touched on this a bit earlier, and I was hoping maybe you can elaborate on the flywheel between Create and Grow and, and how that's trending. Maybe said in another way, are you seeing more customers leveraging both sides of your platform? Is there any given trend, whether it be Create users engaging with ironSource or ironSource using users adopting Create, that you're seeing traction over the last, you know, six or so months? I had one follow-up for Luis.

John Riccitiello (CEO, President, and Chairman)

Okay. First off, we've achieved a lot in the way of synergy, and I would say we're just scratching the surface. There is something sort of chocolate and peanut butter about having the content creation platform and the data that that spins off, the customer relationships that spins off, and the opportunity for those users to consume or purchase other services from us. The Cloud platform is an example. When we're trying to sell UGS UGS before the Cloud platform, it literally required us to get on a plane and talk to somebody and show them a demo. It can literally be a checkbox for so many of our services, including our growth services.

So, at the first level, the synergy we're getting, I don't know if I'd how to measure it, but we're probably getting 10% or 15% of what's potential as we do deeper integration, deeper business model integration, deeper technical integration, more one-click or no-click product integration, so that our customers find the 1 platform thesis high ROI for them. We've been pressing on that for years, talking about it, making it happen. The introduction of a Mediation platform is a big step up because people, you know, developers didn't directly embrace an ad network generally without Mediation in front of it. That was a big step in the right direction. You know, this quarter, we announced some wins, and they, they go, go in both directions.

I expect in the balance of this year, first quarter, next year, the things we're working on that I'd like to share with you, but won't on this call, will be well described in later quarterly calls and/or in, you know, publicly released announcements. We feel really good about, you know, like, how one and one is three and a half here. The value of a platform, probably the most overused word in Silicon Valley, a platform. It's mostly a PowerPoint thesis for most companies that describe it. Here it is substantive, it is real, it matters to our customers, and we're building more value in it. Yes, we are seeing customers come to the platform because of the combination as they move from a Growth service to a Create or Create service to a Grow service.

Gili Naftalovich (Analyst)

Super helpful. I appreciate the response. One for you, Luis, around full-year guide. I mean, given the strength this quarter and the potential upside from new products such as visionOS and some of the others that you highlighted today, how much revenue growth are you currently incorporating in your full-year guide from these services? Or how should we think about the cadence in which they'll start being layered into the growth algorithm?

Luis Visoso (CFO)

Not too much, Gili. I mean, they will... I think they're huge. I think they can make a very significant difference for us on an ongoing basis, but I think they will ramp, in 2024, so I don't have too much in 2023. We should be getting some traction, and, and as John said, you know, customers love them. We're getting good traction on Muse, good traction on Sentis, and, and they should be scaling next year.

John Riccitiello (CEO, President, and Chairman)

We're giving you more visibility on things that that in prior versions of Unity, talking to investors, look like the next two-year revenue ramp, product drive model, and they're all available now. We're, we're sort of at a great spot where we've got more reason to believe in the tailwinds, than we have in years past.

Richard Davis (VP of Investor Relations)

Great.Well, thank you very much.

For the closer here, we'll have, and we'll connect with all of you that had additional questions subsequently, too, as well. Matt Cost, if you're available, we'll let you come in and close the session.

John Riccitiello (CEO, President, and Chairman)

Hey, Matt.

Richard Davis (VP of Investor Relations)

Matt, you may need to unmute yourself, perhaps.

John Riccitiello (CEO, President, and Chairman)

Get the AI bot to stand up and say something.

Richard Davis (VP of Investor Relations)

Exactly.

Luis Visoso (CFO)

We cannot hear you, Matt.

Richard Davis (VP of Investor Relations)

Looks like Matt might be having some issues with his mic.

Okay.

Matt Cost (Analyst)

Can you hear me now?

John Riccitiello (CEO, President, and Chairman)

Ah, there we go.

Matt Cost (Analyst)

Oh, God, okay. I, I pulled it out of the fire, and I'm here to close. Okay. I guess just starting on the pro services side, I mean, you talked about how there's a margin sort of differential between pro services and the rest of the Create business. Understanding that, what is the strategic reason, why operationally is it better not to do pro services? Is that something that's going to have an ongoing impact for two more quarters in, in terms of like, weighing on Create growth, or is that something we've more or less seen? I have one follow-up. Thank you.

John Riccitiello (CEO, President, and Chairman)

Well, I mean, as a starting point, I never intended to scale professional services to a large business. It was definitely a need to do, but until we were proving things, you know, partners like a Capgemini or a Booz weren't interested in us, so we needed to pave the way, we needed to show the way, and we will continue to pave the way and show the way. You know, I find if we as we pull off the transition I'm describing with business model, I believe that SaaS seats plus ratable revenue can scale faster than I can hire people to build low-margin products. Honestly, from a managerial focus perspective, it is an enormous amount of energy that goes into each one of those projects.

It, it's, I don't know if I've got a good, a good way to analogize this, but, you know, I don't think a lot of the Jermyn Street, you know, U.K. tailors that make custom suits have great margins, and they were doing one-offs. That, that's not the vision I have for Unity. I wanna scale. We have a couple of cities, for example, that are running digital twins in Unity. I wanna get all of them on Unity, not just the three I could build city twins for, or the five that I might be able to do next year.

I wanna scale with partners, you know, Capgemini and Booz outnumber us by a wide margin, and so I wanna leverage that infrastructure to deliver for more customers and at the same time, allow us to transform our P&L towards higher margin. So this isn't driven by, primarily, at least, by a cost of capital perspective. It's driven by the complexion of business we want, where our value add is at its best. Now, having said that, you know, we, we did restructure our professional services business in the last couple of quarters, anticipating what we wanted to do. Yeah, we could have generated more revenue this quarter if we hadn't have done that. We'd deliver a little bit more money, more revenue next quarter if we didn't do that, and in the fourth quarter.

My sense is, as we plow through 2024, there'll be more revenue from this decision, not less. One of the things that managers get paid to do is sometimes make, you know. It's always fun to talk about top-line revenue and the growth number and bringing it down a point or so, or whatever that impact would be, in order to transform a business in the right way for long-term profitable growth. That's the right decision, but sometimes it's made with a jealous eye to a little bit more growth that would make, you know, the minute-to-minute feel better. We're not here for tomorrow, we're here for the long term.

Luis Visoso (CFO)

Hey, Matt, just a, a few additional points of clarification. One is, we're not walking away from professional services, right? We're reducing our reliance on professional services, which is a very important distinction. We continue to believe that professional services, to the degree that they are scalable, as John mentioned, are important, right? Why? Because some customers come, and they say, "I, I need a digital twin, but I have no clue how to do it." In some cases where, as John mentioned, we can build a scalable and profitable business, we will be there. But the end game is to move those customers into a subscription business with consumption elements. Super, super important. I don't want you to think that, you know, professional service is gonna go to zero. It remains strategic.

We just need to do it right in a way that it scales to subscription and co- and consumption models. Super important.

Richard Davis (VP of Investor Relations)

Great! Well, that, that wraps up the Q&A session. John, if you wanna close, appreciate it, but thank you all for being on the call for sure.

John Riccitiello (CEO, President, and Chairman)

First off, thank you. Thank you for listening to us for 46 minutes. We appreciate it. The second thought I'd give you is we're, we're very pleased with the quarter. We're really sort of as pleased as we can be about our long-term perspective. Of course, it's our job to string the short term and the long term together in a way that works. We're happy to see the strong margin growth, hitting 18.5% EBIT margins in the second quarter, I think, is ahead of all, most people's expectations, and frankly, if I'd asked me 6 months ago, even my expectations. We feel good about what we're able to do there.

All in, you know, we like our print, we like our guide, we like our future, and we genuinely love a world with more creators in it, it's our job to deliver for them.

Luis Visoso (CFO)

Thank you, everyone.

Richard Davis (VP of Investor Relations)

Thanks.