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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Please read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and related notes included under Part I, Item 1 of this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business, financial condition, or results of operations. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in "Part II, Item 1A. Risk Factors" included elsewhere in this report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements, like all statements in this report, speak only as of their date (unless another date is indicated), and we undertake no obligation to update or revise these statements in light of future developments. See the section titled "Note Regarding Forward-Looking Statements and Risk Factor Summary" in this report.
Overview
Unity offers a suite of tools to create, market and grow games and interactive experiences across all major platforms from mobile, PC, and console, to extended reality (XR).
Our platform consists of two complementary sets of solutions: Create Solutions and Grow Solutions, which together comprise our strategic portfolio surrounding the Unity Engine, Cloud, and Monetization.
Impact of Macroeconomic Trends and Geopolitical Events
Recent macroeconomic factors, such as inflation, interest rates, and credit availability have and could further cause economic uncertainty and volatility, which could harm our business. Further, competition in the advertising market and ongoing restrictions related to the gaming industry in China have impacted our growth rates and may continue to do so. Ongoing geopolitical instability, particularly in Israel, where a significant portion of our Grow Solutions operations is located, may adversely affect our business.
Recent Developments in Our Business
Starting in the fourth quarter of 2023, we began to reset our product and service offerings to focus on our core businesses, which we refer to as our "Strategic Portfolio": the Unity Engine, Cloud, and Monetization, while narrowing our investments in new businesses to those most attractive, mainly industries beyond gaming. We also exited businesses where we do not believe that we can provide unique value to customers or generate a sound return to investors. Specifically, we have limited our Professional Services business to a few selected strategic engagements, we are shifting our multiplayer business to support the demands of live multiplayer games beyond infrastructure, and we have stopped the independent development of professional artistry tools, which we will instead consider integrating into the Unity Editor. During the three and nine months ended September 30, 2024 we recognized approximately $17 million and $75 million, respectively, of revenue associated with these non-strategic portfolios and we expect that these amounts will decline throughout the remainder of 2024.
In the nine months ended September 30, 2024, we substantially completed reductions to our workforce and our office footprint that were announced in the first quarter of 2024. This resulted in approximately $205 million in employee separation costs, primarily related to the acceleration and modifications of equity awards, and $45 million of non-employee charges associated with these reductions.
In the third quarter of 2023, we announced changes to our pricing model for our Create Solutions. We experienced a high volume of negative customer feedback including a boycott and a slow down of signing new contracts and renewals as a result of these changes. In the third quarter of 2024, before the
pricing changes took effect, we announced the cancellation of those pricing changes, the reversion to a subscription-based model, and price increases, for gaming customers. While the initial customer response to this announcement has been positive and we expect this change to benefit our business over the long term, the ultimate impact remains uncertain.
We have had significant executive transitions in 2024. In the fourth quarter of 2024, we announced the hiring of our permanent Senior Vice President and Chief Financial Officer, Jarrod Yahes, effective January 1, 2025. Mark Barrysmith, our Senior Vice President and Chief Accounting Officer and Interim Chief Financial Officer, will no longer serve as the Interim Chief Financial Officer as of January 1, 2025, but will continue in his role as Senior Vice President and Chief Accounting Officer and will continue as our Principal Accounting Officer. Our ability to successfully manage these executive transitions, and to retain senior executives is critical to our success and the timing and full impact on our future results of operations, cash flows, or financial condition are uncertain.
For additional details, refer to the section titled "Risk Factors."
Key Metrics
As further discussed in Item 2 of Part I, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K, we monitor the following key metrics to help us evaluate the health of our business, identify trends affecting our growth, formulate goals and objectives, and make strategic decisions. We have revised and restated these metrics to include inputs from our Strategic Portfolio only.
Customers Contributing More Than $100,000 of Revenue
We had 1,242 and 1,230 customers contributing more than $100,000 of revenue in the trailing 12 months as of September 30, 2024 and 2023, respectively. The year over year increase was largely a result of our core subscriptions growth. While these customers represented the substantial majority of revenue for the nine months ended September 30, 2024 and 2023, respectively, no one customer accounted for more than 10% of our revenue for either period.
Dollar-Based Net Expansion Rate
Our ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with our Create and Grow Solutions customers and to increase their use of our platform. We track our performance by measuring our dollar-based net expansion rate, which compares our Create and Grow Solutions revenue, excluding Strategic Partnerships and Supersonic, from the same set of customers across comparable periods, calculated on a trailing 12-month basis.
| | | | | | | | | | | |
| As of |
| September 30, 2024 | | September 30, 2023 |
| Dollar-based net expansion rate | 94 | % | | 102 | % |
Our dollar-based net expansion rate as of September 30, 2024 was driven primarily by decreases in Grow Solutions revenue, due to competition in the advertising market, and to a lesser extent decreases in professional services revenue within Create Solutions, offset by growth in core subscriptions revenue. Our dollar-based net expansion rate as of September 30, 2023 was driven primarily by growth in professional services, and core subscriptions revenue, due to sales of additional subscriptions and services to our existing Create Solutions customers and cross-selling our solutions to all of our customers. The decrease in dollar-based net expansion rate, compared to the comparable prior year period, is attributable to declines in Grow Solutions, and professional services revenue, as noted above.
The chart below illustrates that our dollar-based net expansion rate has been declining over the last year.
Results of Operations
The following table summarizes our historical consolidated statements of operations data for the periods indicated (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2024 | | 2023 | | 2024 | | 2023 |
| Revenue | $ | 446,517 | | | $ | 544,210 | | | $ | 1,356,156 | | | $ | 1,578,049 | |
| Cost of revenue | 112,054 | | | 151,349 | | | 365,316 | | | 472,140 | |
| Gross profit | 334,463 | | | 392,861 | | | 990,840 | | | 1,105,909 | |
| Operating expenses | | | | | | | |
| Research and development | 215,197 | | | 240,003 | | | 706,860 | | | 788,438 | |
| Sales and marketing | 176,423 | | | 194,000 | | | 576,902 | | | 619,258 | |
| General and administrative | 69,989 | | | 86,256 | | | 338,573 | | | 272,047 | |
| Total operating expenses | 461,609 | | | 520,259 | | | 1,622,335 | | | 1,679,743 | |
| Loss from operations | (127,146) | | | (127,398) | | | (631,495) | | | (573,834) | |
| Interest expense | (5,839) | | | (6,154) | | | (17,703) | | | (18,425) | |
| Interest income and other income (expense), net | 15,350 | | | 16,013 | | | 102,450 | | | 38,689 | |
| Loss before income taxes | (117,635) | | | (117,539) | | | (546,748) | | | (553,570) | |
| Provision for (benefit from) Income taxes | 6,913 | | | 7,771 | | | (4,984) | | | 18,767 | |
| Net loss | $ | (124,548) | | | $ | (125,310) | | | $ | (541,764) | | | $ | (572,337) | |
The following table sets forth the components of our condensed consolidated statements of operations data as a percentage of revenue for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2024 | | 2023 | | 2024 | | 2023 |
| Revenue | 100 | % | | 100 | % | | 100 | % | | 100 | % |
| Cost of revenue | 25 | | | 28 | | | 27 | | | 30 | |
| Gross profit | 75 | | | 72 | | | 73 | | | 70 | |
| Operating expenses | | | | | | | |
| Research and development | 48 | | | 44 | | | 52 | | | 50 | |
| Sales and marketing | 40 | | | 36 | | | 43 | | | 39 | |
| General and administrative | 15 | | | 15 | | | 25 | | | 17 | |
| Total operating expenses | 103 | | | 95 | | | 120 | | | 106 | |
| Loss from operations | (28) | | | (23) | | | (47) | | | (36) | |
| Interest expense | (1) | | | (2) | | | (1) | | | (1) | |
| Interest income and other income (expense), net | 3 | | | 3 | | | 8 | | | 2 | |
| Loss before income taxes | (26) | | | (22) | | | (40) | | | (35) | |
| Provision for (benefit from) Income taxes | 2 | | | 1 | | | — | | | 1 | |
| Net loss | (28) | % | | (23) | % | | (40) | % | | (36) | % |
Revenue
Create Solutions
We generate Create Solutions revenue primarily through our suite of Create Solutions subscriptions inclusive of enterprise support, professional services, and cloud and hosting services. Our subscriptions provide customers access to technologies that allow them to edit, run, and iterate interactive, RT3D and 2D experiences that can be created once and deployed to a variety of platforms. Enhanced support services are provided to our enterprise customers and are sold separately from the Create Solutions subscriptions. Professional services are provided to our customers and include consulting, platform integration, training, and custom application and workflow development. Cloud and hosting services are provided to our customers to simplify and enhance the way our users access and harness our solutions.
Grow Solutions
We generate Grow Solutions revenue primarily through our monetization solutions and game publishing services. Our monetization solutions allow publishers, original equipment manufacturers, and mobile carriers to sell available advertising inventory on their mobile applications or hardware devices to advertisers for in-application or on-device placements. Our revenue represents the amount we retain from the transaction we are facilitating through our Unified Auction and mediation platform. Our game publishing services provide game developers with the infrastructure and expertise to launch their mobile games and manage their growth; this is achieved through marketability testing tools, live games management tools and game design support, and optimizing the implementation of the customer's commercial model. Through these publishing services, we generate revenue from in-app advertising in published games and in some cases, in app purchase revenue.
Our total revenue is summarized as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2024 | | 2023 | | 2024 | | 2023 |
| Create Solutions | $ | 147,369 | | | $ | 188,900 | | | $ | 461,816 | | | $ | 569,379 | |
| Grow Solutions | 299,148 | | | 355,310 | | | 894,340 | | | 1,008,670 | |
| Total revenue | $ | 446,517 | | | $ | 544,210 | | | $ | 1,356,156 | | | $ | 1,578,049 | |
Total revenue decreased in the three and nine months ended September 30, 2024, compared to the comparable prior year periods, primarily due to a decrease in Grow Solutions revenue, which was negatively impacted by competition. To be more competitive we are focused on enhancing our machine learning stack and data infrastructure capabilities, which we believe will take some time to manifest in sustainable increased performance. The decrease in total revenue was further driven by a decrease in Create Solutions revenue, primarily due to the termination of the subscription agreement with Wētā FX Limited, and a decrease in professional services revenue and cloud and hosting services revenue, both caused by the portfolio reset. The decrease in Create Solutions was partially offset by increases in subscription revenue.
Cost of Revenue, Gross Profit, and Gross Margin
Cost of revenue consists primarily of personnel costs (including salaries, benefits, and stock-based compensation) for employees and subcontractors associated with our product support and professional services organizations, the amortization of intangible assets, hosting expenses, and costs of related facilities.
Gross profit, or revenue less cost of revenue, has been and will continue to be affected by various factors, including our product mix, the costs associated with third-party hosting services and the extent to which we expand and drive efficiencies in our hosting costs, professional services, and customer support organizations. We expect our gross profit to increase in absolute dollars in the long term but decrease in the short term as we reset our product portfolio to focus on the Unity Engine, Cloud, and Monetization solutions. We expect our gross profit as a percentage of revenue, or gross margin, to fluctuate from period to period.
Cost of revenue for the three and nine months ended September 30, 2024 decreased, compared to the comparable prior year periods, primarily due to a decrease in personnel costs, driven by our reductions in headcount, a decrease in amortization expenses related to intangible assets acquired through our business combinations, and a decrease in our hosting expenses in line with decreases in related revenue.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The most significant component of our operating expenses is personnel-related costs, including salaries and wages, sales commissions, bonuses, benefits, stock-based compensation, and payroll taxes. As part of our efforts to restructure and streamline our organizational structure, in January 2024, we committed to a plan to eliminate approximately 25% of our workforce, and we mutually agreed to the departure of the founders of ironSource Ltd. Following these announcements and substantially in the first quarter of 2024, we incurred incremental employee separation costs of approximately $205 million in the nine months ended September 30, 2024, largely driven by the acceleration and modification of equity awards, including $15 million within cost of revenue, $46 million within research and development expense, $52 million within sales and marketing expense, and $92 million within general and administrative expense. In addition, we incurred $45 million of non-employee charges associated with this restructuring.
Research and Development
Research and development expenses primarily consist of personnel-related costs for the design and development of our platform, IT hosting and SaaS expenses, and amortization expenses related to intangible assets. We expect our research and development expenses to increase in absolute dollars in the long term, as we expand our teams to develop new solutions, expand features and functionality with existing solutions, and enter new markets, but decrease in the short term as we reset our Strategic Portfolio. We expect research and development expenses to fluctuate as a percentage of revenue from period to period.
Research and development expense for the three and nine months ended September 30, 2024 decreased, compared to the comparable prior year periods, primarily due to a decrease in personnel costs driven by our reductions in headcount in the first quarter of 2024.
Sales and Marketing
Our sales and marketing expenses consist primarily of personnel-related costs, amortization expenses related to intangible assets, and advertising and marketing programs, including user acquisition costs and digital account-based marketing, user events such as developer-centric conferences and our annual Unite user conferences. We expect that our sales and marketing expense will increase in absolute dollars in the long term, as we hire additional personnel, increase our account-based marketing, direct marketing and community outreach activities, invest in additional tools and technologies, and continue to build brand awareness, but decrease in the short term as we reset our Strategic Portfolio. We expect sales and marketing expenses to fluctuate as a percentage of revenue from period to period.
Sales and marketing expense for the three and nine months ended September 30, 2024 decreased, compared to the comparable prior year periods, primarily due to a decrease in personnel costs, driven by our reductions in headcount in the first quarter of 2024.
General and Administrative
Our general and administrative expenses primarily consist of personnel-related costs for finance, legal, human resources, IT and administrative employees; allocated overhead, and professional fees for external legal, accounting, and other professional services. We expect that our general and administrative expenses will increase in absolute dollars in the long term, as we scale to support the growth of our business but decrease in the short term as we reset our Strategic Portfolio. We expect general and administrative expenses to fluctuate as a percentage of revenue from period to period.
General and administrative expense for the three months ended September 30, 2024 decreased, compared to the comparable prior year period, primarily due to a decrease in personnel-related costs, driven by our reductions in headcount in the first quarter of 2024. General and administrative expense for the nine months ended September 30, 2024 increased, compared to the comparable prior year period, primarily due to higher personnel-related costs, driven by employee separation costs in the first quarter of 2024, impairments of operating lease assets, and an increase in our professional fees.
Interest Expense
Interest expense consists primarily of interest expense associated with our convertible debt and amortization of debt issuance costs.
Interest expense for the three and nine months ended September 30, 2024 decreased, compared to the comparable prior year periods, in line with our outstanding debt obligations.
Interest Income and Other Income (Expense), Net
Interest income and other income (expense), net, consists primarily of gains on the repurchase of convertible debt, interest income earned on our cash, cash equivalents, and short-term investments, and foreign currency gains and losses. As we have expanded our global operations, our exposure to fluctuations in foreign currencies has increased, and we expect this to continue.
Interest income and other income (expense), net, for the three months ended September 30, 2024 decreased, compared to the comparable prior year period, primarily due to a decrease in interest bearing accounts, driven by the use of cash to repurchase a portion of our convertible debt in the first quarter of 2024, offset by foreign currency gains and losses. Interest income and other income (expense), net, for the nine months ended September 30, 2024 increased, compared to the comparable prior year period, primarily due to gains on the repurchase of convertible debt of $61.4 million in the first quarter of 2024.
Provision for (benefit from) Income taxes
Provision for (benefit from) income taxes consists primarily of income taxes in certain foreign jurisdictions where we conduct business. We have a valuation allowance against certain of our deferred tax assets, including net operating loss ("NOL") carryforwards and tax credits related primarily to research and development. Our overall effective income tax rate in future periods may be affected by the geographic mix of earnings in the countries in which we operate. Our future effective tax rate may also be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles in the jurisdictions in which we conduct business. See Note 9, "Income Taxes," of the Notes to Condensed Consolidated Financial Statements.
Provision for income taxes for the three months ended September 30, 2024 decreased, compared to the comparable prior year period, primarily due to decrease in earnings in foreign jurisdictions with lower effective tax rate. Benefit from income taxes for the nine months ended September 30, 2024 changed as compared to the provision for income taxes in the comparable prior year period, primarily due to a tax benefit from our foreign losses in connection with employee separation costs recorded in the first quarter of 2024 and our continued restructuring efforts in the first quarter of 2024 that enhanced our ability to offset deferred tax liabilities in the U.S. in future periods, thereby partially reducing the need for a valuation allowance.
Non-GAAP Financial Measures
To supplement our consolidated financial statements prepared and presented in accordance with GAAP, we use certain non-GAAP financial measures, as described below, to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe the following non-GAAP measures are useful in evaluating our operating performance. We are presenting these non-GAAP financial measures because we believe, when taken collectively, they may be helpful to investors because they provide consistency and comparability with past financial performance.
However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. As a result, our non-GAAP financial measures are presented for supplemental informational purposes only and should not be considered in isolation or as a substitute for our consolidated financial statements presented in accordance with GAAP.
Adjusted Gross Profit and Adjusted EBITDA
We define adjusted gross profit as GAAP gross profit excluding expenses associated with stock-based compensation, amortization of acquired intangible assets, depreciation, and restructurings and reorganizations. We define adjusted gross margin as adjusted gross profit as a percentage of revenue. We define adjusted EBITDA as net income or loss excluding benefits or expenses associated with stock-based compensation, amortization of acquired intangible assets, depreciation, restructurings and reorganizations, interest, income tax, and other non-operating activities, which primarily consist of foreign exchange rate gains or losses.
We use adjusted gross profit and adjusted EBITDA in conjunction with traditional GAAP measures to evaluate our financial performance. We believe that adjusted gross profit and adjusted EBITDA provide our management and investors consistency and comparability with our past financial performance and
facilitates period-to-period comparisons of operations, as these metrics exclude expenses that we do not consider to be indicative of our overall operating performance.
The following table presents a reconciliation of our adjusted gross profit to our GAAP gross profit, the most directly comparable measure as determined in accordance with GAAP, for the periods presented (in thousands):
| | | | | | | | | | | |
| Three Months Ended |
| September 30, |
| 2024 | | 2023 |
| GAAP gross profit | $ | 334,463 | | | $ | 392,861 | |
| Add: | | | |
| Stock-based compensation expense | 10,334 | | | 19,591 | |
| | | |
| Amortization of intangible assets expense | 27,293 | | | 35,191 | |
| Depreciation expense | 2,265 | | | 2,892 | |
| Restructuring and reorganization costs | 77 | | | — | |
| Adjusted gross profit | $ | 374,432 | | | $ | 450,535 | |
| GAAP gross margin | 75 | % | | 72 | % |
| Adjusted gross margin | 84 | % | | 83 | % |
The following table presents a reconciliation of our adjusted EBITDA to net loss, the most directly comparable measure as determined in accordance with GAAP, for the periods presented (in thousands):
| | | | | | | | | | | |
| Three Months Ended |
| September 30, |
| 2024 | | 2023 |
| GAAP net loss | $ | (124,548) | | | $ | (125,310) | |
| Stock-based compensation expense | 105,271 | | | 147,177 | |
| Amortization of intangible assets expense | 88,517 | | | 99,220 | |
| Depreciation expense | 14,083 | | | 11,977 | |
| | | |
| Restructuring and reorganization costs | 10,997 | | | — | |
| | | |
| | | |
| Interest expense | 5,839 | | | 6,154 | |
| Interest income and other income (expense), net | (15,350) | | | (16,013) | |
| Provision for Income taxes | 6,913 | | | 7,771 | |
| Adjusted EBITDA | $ | 91,722 | | | $ | 130,976 | |
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