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Unity (NYSE:U) Reports Bullish Q2, Lifts Full Year Guidance


Full Report / August 10, 2021
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Game engine maker Unity (NYSE:U) reported Q2 FY2021 results beating Wall St's expectations, with revenue up 48.4% year on year to $273.5 million. Unity made a GAAP loss of $148.3 million, down on its loss of $27.3 million, in the same quarter last year.

Unity (U) Q2 FY2021 Highlights:

  • Revenue: $273.5 million vs analyst estimates of $242.7 million (12.6% beat)
  • EPS (non-GAAP): -$0.02 vs analyst estimates of -$0.12
  • Revenue guidance for Q3 2021 is $262.5 million at the midpoint, above analyst estimates of $254 million
  • The company lifted revenue guidance for the full year, from $1 billion to $1.05 billion at the midpoint, a 4.46% increase
  • Free cash flow was negative -$33.49 million, compared to negative free cash flow of -$100.63 million in previous quarter
  • Net Revenue Retention Rate: 142%, in line with previous quarter
  • Customers: 888 customers paying more than $100,000 annually
  • Gross Margin (GAAP): 78.8%, up from 74.9% previous quarter

Founded in 2004 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.

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 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 year, growing from quarterly revenue of $184.3 million, to $273.5 million.

Unity Total Revenue

And unsurprisingly, this was another great quarter for Unity with revenue up an absolutely stunning 48.4% year on year. On top of that, revenue increased $38.7 million quarter on quarter, a very strong improvement on the $14.4 million increase in Q1 2021, and a sign of acceleration of growth.

Analysts covering the company are expecting the revenues to grow 24% over the next twelve months, although we would expect them to review their estimates once they get to read these results.

Large Customers Growth

You can see below that at the end of the quarter Unity reported 888 enterprise customers paying more than $100,000 annually, an increase of 51 on last quarter. That is quite a bit more contract wins than last quarter and about the same as what we have seen lately, demonstrating the company has the sales momentum required to drive continued growth. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is running smoothly.

Unity customers paying more than $100,000 annually

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

Unity Net Revenue Retention Rate

Unity's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 142% in Q2. That means even if they didn't win any new customers, Unity would have grown its revenue 42% year on year. Significantly up from the last quarter, this is an absolutely exceptional retention rate, meaning Unity's software is extremely successful with their customers who are rapidly expanding the use of it across their organizations.

Profitability

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 is left after paying for servers, licences, technical support and other necessary running expenses was at 78.8% in Q2.

Unity Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.78 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is a good gross margin that allows companies like Unity to fund large investments in product and sales during periods of rapid growth and be profitable when they reach reaches maturity.

Key Takeaways from Unity's Q2 Results

Since it has still been burning cash over the last twelve months it is worth keeping an eye on Unity’s balance sheet, but we note that with market capitalisation of $30.8 billion and more than $1.58 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were impressed by how strongly Unity outperformed analysts’ revenue expectations this quarter. And we were also excited to see the really strong revenue growth. Zooming out, we think this was a great quarter and we have no doubt shareholders will feel excited about the results. The company is up 2.8% on the results and currently trades at $110.15 per share.

Is Now The Time?

When considering Unity, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Unity is a good business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last two years. And while its cash burn means its business isn't yet sustainable, the good news is its very efficient customer acquisition hints at the potential for strong profitability, and its customers are increasing their spending quite quickly, suggesting that they love the product.

The market is certainly expecting long term growth from Unity given its price to sales ratio based on the next twelve months is 26.2. There is definitely a lot of things to like about Unity and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.

The Wall St analysts covering the company had a one year price target of $123.3 per share right before these results, implying that they saw upside in buying Unity even in short term.