Unity (NYSE:U) Beats Q3 Sales Targets But Stock Drops

Full Report / November 09, 2021
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Game engine maker Unity (NYSE:U) beat analyst expectations in Q3 FY2021 quarter, with revenue up 42.6% year on year to $286.3 million. The company expects that next quarter's revenue would be around $287.5 million, which is the midpoint of the guidance range. That was in roughly line with analyst expectations. Unity made a GAAP loss of $115.1 million, improving on its loss of $144.7 million, in the same quarter last year.

Unity (U) Q3 FY2021 Highlights:

  • Revenue: $286.3 million vs analyst estimates of $266.3 million (7.49% beat)
  • EPS (non-GAAP): $0.35 vs analyst estimates of -$0.07 ($0.42 beat)
  • Revenue guidance for Q4 2021 is $287.5 million at the midpoint, roughly in line with what analysts were expecting
  • Free cash flow of $34.2 million, up from negative free cash flow of -$33.49 million in previous quarter
  • Net Revenue Retention Rate: 142%, in line with previous quarter
  • Customers: 973 customers paying more than $100,000 annually
  • Gross Margin (GAAP): 77.8%, up from 76.3% same quarter last year
  • Unity announced today it has entered into a definitive agreement to acquire Weta Digital

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.

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 $200.7 million, to $286.3 million.

Unity Total Revenue

And unsurprisingly, this was another great quarter for Unity with revenue up an absolutely stunning 42.6% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $12.7 million in Q3, compared to $38.7 million in Q2 2021. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Analysts covering the company are expecting the revenues to grow 25.5% over the next twelve months, although estimates are likely to change post earnings.

Large Customers Growth

You can see below that at the end of the quarter Unity reported 973 enterprise customers paying more than $100,000 annually, an increase of 85 on last quarter. That is quite a bit more contract wins than last quarter and quite a bit above what we have typically seen lately, demonstrating that the business itself has good sales momentum. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is working very well.

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 Q3. That means even if they didn't win any new customers, Unity would have grown its revenue 42% year on year. That 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.


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, licenses, technical support and other necessary running expenses was at 77.8% in Q3.

Unity Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.77 left to spend on developing new products, marketing & sales and the general administrative overhead. Despite the recent drop, this is still 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 maturity.

Key Takeaways from Unity's Q3 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 a market capitalization of $46 billion and more than $1.28 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were very impressed how strongly Unity accelerated the rate of new contract wins this quarter. And we were also excited to see the really strong revenue growth. On the other hand, there was a deterioration in gross margin. Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. But the market didn't react to the news positively and the company is down 9.59% on the results and currently trades at $155 per share.

Is Now The Time?

Unity may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. 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 raises the question if it can sustainably maintain its growth, the good news is its customers are increasing their spending quite quickly, suggesting that they love the product, and its very efficient customer acquisition hints at the potential for strong profitability.

Unity's price to sales ratio based on the next twelve months of 38.3x indicates that the market is certainly optimistic about its growth prospects. 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.

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