Unity (NYSE:U) Beats Q4 Sales Targets But Stock Drops 15.7%

Full Report / February 26, 2024

Game engine maker Unity (NYSE:U) reported Q4 FY2023 results beating Wall Street analysts' expectations, with revenue up 35.1% year on year to $609.3 million. On the other hand, next quarter's revenue guidance of $417.5 million was less impressive, coming in 30.8% below analysts' estimates. It made a GAAP loss of $0.66 per share, down from its profit of $0.04 per share in the same quarter last year.

Unity (U) Q4 FY2023 Highlights:

  • Revenue: $609.3 million vs analyst estimates of $585.5 million (4.1% beat)
  • EPS: -$0.66 vs analyst expectations of -$0.48 (38.9% miss)
  • Revenue Guidance for Q1 2024 is $417.5 million at the midpoint, below analyst estimates of $603 million
  • Management's revenue guidance for the upcoming financial year 2024 is $1.78 billion at the midpoint, missing analyst estimates by 31.4% and implying -18.6% growth (vs 59.9% in FY2023)
  • Free Cash Flow of $60.74 million, down 41.6% from the previous quarter
  • Gross Margin (GAAP): 57.1%, down from 69.7% in the same quarter last year
  • Market Capitalization: $11.88 billion

Started as a game studio by three friends in a Copenhagen apartment, Unity (NYSE:U) is a software as a service platform that makes it easier to develop and monetize new games and other visual digital experiences.

Instead of having to build everything from scratch, game developers can use Unity’s game engine that handles things like the physics of how players and objects move or how networking and in-app purchases work.

Similarly to when opening a new restaurant a chef just buys an oven and other tools needed, and focuses their effort on the recipes and the food, a game developer can now focus on the story, characters and rules of their game rather than having to build their own tools. While it has been lately venturing into VR and movie production, Unity is still most popular with mobile game makers, powering a large share of the top 1,000 games.

Design Software

The demand for rich, interactive 2D, 3D, VR and AR experiences is growing, and while the ubiquitous metaverse might still be more of a buzzword than a real thing, what is real is the demand for the tools to create these experiences, whether they are games, 3D tours or interactive movies.

Competitors include Autodesk (NASDAQ: ADSK), Blender, Unreal Engine, and Roblox (NYSE:RBLX).

Sales Growth

As you can see below, Unity's revenue growth has been impressive over the last two years, growing from $315.9 million in Q4 FY2021 to $609.3 million this quarter.

Unity Total Revenue

Unsurprisingly, this was another great quarter for Unity with revenue up 35.1% year on year. On top of that, its revenue increased $65.06 million quarter on quarter, a very strong improvement from the $10.73 million increase in Q3 2023. This is a sign of acceleration of growth and great to see.

Next quarter, Unity is guiding for a 16.6% year-on-year revenue decline to $417.5 million, a further deceleration from the 56.3% year-on-year decrease it recorded in the same quarter last year. For the upcoming financial year, management expects revenue to be $1.78 billion at the midpoint, declining 18.6% year on year compared to the 57.2% increase in FY2023.


What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Unity's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 57.1% in Q4.

Unity Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.57 left to spend on developing new products, sales and marketing, and general administrative overhead. Unity's gross margin is poor for a SaaS business and it's dropped significantly since the previous quarter. This is probably the exact opposite of what shareholders would like to see.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Unity's free cash flow came in at $60.74 million in Q4, turning positive over the last year.

Unity Free Cash Flow

Unity has generated $178.8 million in free cash flow over the last 12 months, or 8.2% of revenue. This FCF margin enables it to reinvest in its business without depending on the capital markets.

Key Takeaways from Unity's Q4 Results

We struggled to find many strong positives in these results as the company's full-year 2024 revenue and EPS guidance fell short of analysts' estimates. Although this quarter's headline revenue beat, Unity stated it benefitted from a unique event where one of its customers, Wētā, terminated its service agreement and opted for a perpetual license to access its software. This resulted in a one-time revenue boost of $99 million - without this sale, Unity's revenue would have been $510 million, dropping 2% year on year.

In its shareholder letter, James Whitehurst, the company's recently appointed CEO (October 2023), also shared Unity's new strategy. The company's reset will be split into two phases, the first being to focus on its core business by narrowing its investments. Unity also intends to right-size its cost structure, as seen in its January 8th layoff of 25% of its workforce. Phase one is expected to finish by the end of Q1, and once Unity's leaner cost base is established, it plans to return to growth initiatives and new product development.

Overall, this was a mediocre quarter for Unity, and investors are likely uncomfortable with the company's outlook. The stock is down 15.7% on the results and currently trades at $27.83 per share. 

Is Now The Time?

When considering an investment in Unity, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.

Although we have other favorites, we understand the arguments that Unity isn't a bad business. We'd expect growth rates to moderate from here, but its . And while its gross margins aren't as good as other tech businesses we look at, the good news is its efficient customer acquisition is better than many similar companies.

Unity's price-to-sales ratio based on the next 12 months is 4.8x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. There are things to like about Unity and there's no doubt it's a bit of a market darling, at least for some. But we are wondering whether there might be better opportunities elsewhere right now.

Wall Street analysts covering the company had a one-year price target of $42.33 per share right before these results (compared to the current share price of $27.83).

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