Unity (U)

Interactive software platform Unity (NYSE:U) reported revenue ahead of Wall Streets expectations in Q3 CY2025, with sales up 5.4% year on year to $470.6 million. Guidance for next quarter’s revenue was better than expected at $485 million at the midpoint, 1.2% above analysts’ estimates. Its non-GAAP profit of $0.20 per share was 19.6% above analysts’ consensus estimates.

Company Overview

Powering over half of the world's mobile games and expanding into industries from automotive to architecture, Unity (NYSE:U) provides software tools and services that allow developers to create, run, and monetize interactive 2D and 3D content across multiple platforms.

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.

Unity competes with Epic Games' Unreal Engine in the game development space, proprietary in-house engines at large game studios, and open-source alternatives like Godot. In the monetization sector, Unity faces competition from AppLovin (NYSE:APP), Digital Turbine (NASDAQ:APPS), and divisions of tech giants like Google (NASDAQ:GOOGL), Meta (NASDAQ:META), and Amazon (NASDAQ:AMZN).

A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Unity grew its sales at a decent 20.5% compounded annual growth rate. Its growth was slightly above the average software company and shows its offerings resonate with customers.

Long-term growth is the most important, but within software, a half-decade historical view may miss new innovations or demand cycles. Unity’s recent performance marks a sharp pivot from its five-year trend as its revenue has shown annualized declines of 5.7% over the last two years.

This quarter, Unity reported year-on-year revenue growth of 5.4%, and its $470.6 million of revenue exceeded Wall Street’s estimates by 4.6%. Company management is currently guiding for a 6.1% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 8.3% over the next 12 months. While this projection implies its newer products and services will spur better top-line performance, it is still below average for the sector.

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Unity’s billings came in at $478.1 million in Q3, and it averaged 2.5% year-on-year declines over the last four quarters. However, this alternate topline metric outperformed its total sales, meaning the company collects cash upfront and then recognizes the revenue over the length of its contracts - a boost for its liquidity and future revenue prospects.

The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.

Unity is efficient at acquiring new customers, and its CAC payback period checked in at 42 months this quarter. The company’s relatively fast recovery of its customer acquisition costs means it can attempt to spur growth by increasing its sales and marketing investments.

For software companies like Unity, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.

Unity’s gross margin is better than the broader software industry and signals it has solid unit economics and competitive products. As you can see below, it averaged a decent 74.3% gross margin over the last year. Said differently, Unity paid its providers $25.67 for every $100 in revenue.

The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Unity has seen gross margins improve by 4.3 percentage points over the last 2 year, which is very good in the software space.

Unity’s gross profit margin came in at 74.4% this quarter, in line with the same quarter last year. On a wider time horizon, Unity’s full-year margin has been trending up over the past 12 months, increasing by 4.8 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as servers).

Unity’s expensive cost structure has contributed to an average operating margin of negative 27.5% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Unity reeled back its investments. Wall Street seems to think it will face some obstacles, and we tend to agree.

Over the last two years, Unity’s expanding sales gave it operating leverage as its margin rose by 17.8 percentage points. Still, it will take much more for the company to reach long-term profitability.

In Q3, Unity generated a negative 26.7% operating margin.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Unity has shown impressive cash profitability, driven by its cost-effective customer acquisition strategy that gives it the option to invest in new products and services rather than sales and marketing. The company’s free cash flow margin averaged 21.7% over the last year, better than the broader software sector. The divergence from its underwhelming operating margin stems from the add-back of non-cash charges like depreciation and stock-based compensation. GAAP operating profit expenses these line items, but free cash flow does not.

Unity’s free cash flow clocked in at $151.3 million in Q3, equivalent to a 32.1% margin. This result was good as its margin was 6.3 percentage points higher than in the same quarter last year, but we wouldn’t put too much weight on the short term because investment needs can be seasonal, causing temporary swings. Long-term trends trump fluctuations.

Unity reported $1.90 billion of cash and $2.23 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company’s debt level isn’t too high and 2) that its interest payments are not excessively burdening the business.

With $390 million of EBITDA over the last 12 months, we view Unity’s 0.9× net-debt-to-EBITDA ratio as safe. We also see its $96.33 million of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

We were impressed by how significantly Unity blew past analysts’ EBITDA expectations this quarter. We were also happy its revenue outperformed Wall Street’s estimates. On the other hand, its EBITDA guidance for next quarter missed. Overall, this print had some key positives. The stock traded up 10% to $39.45 immediately following the results.

Updated: December 4, 2025 at 9:10 PM EST

Before deciding whether to buy Unity or pass, we urge investors to consider business quality, valuation, and the latest quarterly results.

Unity doesn’t pass our quality test. Although its revenue growth was solid over the last five years, it’s expected to deteriorate over the next 12 months and its operating margins reveal poor profitability compared to other software companies.

Unity’s price-to-sales ratio based on the next 12 months is 9.4x. This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere.

Wall Street analysts have a consensus one-year price target of $44.51 on the company (compared to the current share price of $44.15).