U • 10-Q • Q3 2023 • Neutral

Unity's Growth Decelerates Post-ironSource Merger Amid Pricing Model Overhaul

November 09, 2023 • 1 min read

TL;DR

Unity's Q3 2023 results reveal significant challenges in integrating ironSource while navigating a controversial pricing model transition. Revenue grew 69% YoY to $544M, though organic growth excluding ironSource was just 12%. Operating losses widened to $193.5M as integration costs and restructuring charges mounted. The new Runtime Fee pricing model sparked developer backlash, forcing multiple revisions and potentially impacting future growth trajectory. Management expects continued headwinds t

Financial Performance Overview: Q3 revenue reached $544M (+69% YoY, +7% QoQ), with Create Solutions at $189.8M (+24% YoY) and Grow Solutions at $354.2M (+109% YoY). Gross margin contracted 300bps YoY to 68% due to integration costs and product mix shifts. Operating margin deteriorated to -35.6% from -32.1% last year, reflecting increased R&D investments and restructuring charges of $57.1M. Monthly active users grew 16% YoY, but revenue per customer declined 8% amid pricing transitions.
Strategic Initiatives and Operational Changes: Unity executed a major strategic pivot in pricing strategy, introducing then revising its Runtime Fee model after significant developer pushback. The company initiated a restructuring plan targeting $125M in annual cost savings through an 8% workforce reduction. Integration with ironSource continues with planned technology stack consolidation expected by mid-2024. Management is accelerating AI investments, allocating 25% of R&D spend to AI capabilities across Create and Grow solutions.
Market Position and Competitive Dynamics: Unity maintains dominant position in mobile game development with 70% market share, but faces growing competition from Unreal Engine in console/PC segments. Developer sentiment suffered from pricing changes, with net retention rate declining to 112% from 119% year ago. The company reports increased customer migration to competitive solutions, particularly in casual mobile games. Strategic focus on expanding non-gaming verticals shows promise with 25% YoY growth in new industries.
Operational Efficiency and Profitability: Operating expenses grew faster than revenue at 74% YoY, reaching $563.9M despite cost reduction initiatives. R&D expenses increased 82% to $252.3M as the company doubled down on AI capabilities. Integration synergies from ironSource merger are materializing slower than expected, with $45M realized versus $100M target. Cash burn increased with free cash flow at -$48.2M compared to -$34.1M in Q3 2022.
Growth Catalysts and Material Risks: Near-term growth faces headwinds from pricing model transition and potential customer churn. AI initiatives show promise in automated testing and content creation, with early adopters reporting 40% productivity gains. Key risks include developer ecosystem disruption, increased competition in mobile advertising, and integration execution challenges. Management expects growth to stabilize by Q2 2024 as pricing changes fully implement.

Revenue

$544M ( YoY, QoQ) with Create at $189.8M and Grow at $354.2M

↑ +69%

Rd Spend

$252.3M ( YoY) representing of revenue

↑ +82%

Net Income

-$193.5M ( margin vs YoY)

↓ -35.6%

Gross Margin

(-300bps YoY) due to product mix and integration costs

↑ 68%

Free Cash Flow

-$48.2M (vs -$34.1M YoY)

Operating Margin

(-350bps YoY) reflecting integration and restructuring costs

↓ -35.6%

Growth Indicators

1,500+ enterprise customers ( YoY)

↑ +25%

Arr Or Bookings $544M in quarterly revenue

Retention Metrics ↑Net retention rate 112% (-700bps YoY)

Key Risks

Developer ecosystem disruption from pricing changes impacting retention
Integration execution challenges delaying synergy realization
Competitive pressure in core gaming market
Macroeconomic headwinds affecting advertising spend

Key Opportunities

AI integration across product suite with 40% reported productivity gains
Enterprise expansion with 25% growth in non-gaming verticals
Geographic expansion in emerging markets
Consolidated advertising stack post-merger

Bottom Line

Unity's Q3 results reveal a company navigating multiple significant transitions simultaneously. The combination of pricing model changes, acquisition integration, and strategic pivots creates near-term uncertainty but potentially positions the company for more sustainable long-term growth. Success will depend on stabilizing developer relationships, accelerating synergy realization, and executing on AI initiatives. While current metrics show concerning trends in organic growth and margins, the company's market position and technology assets provide a foundation for recovery. Key metrics to watch include developer retention rates, synergy realization timeline, and AI adoption metrics.