Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in "Part I, Item 1A. Risk Factors" included elsewhere in this report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business, financial condition or results of operations. See the section titled "Note Regarding Forward-Looking Statements" in this report. These statements, like all statements in this report, speak only as of their date (unless another date is indicated), and we undertake no obligation to update or revise these statements in light of future developments. For a discussion of our consolidated statement of operations data for the year endedDecember 31, 2018 , see "Comparison of the Years EndedDecember 31, 2019 and 2018" under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operation" in our final prospectus datedSeptember 17, 2020 and filed with theSEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, onSeptember 18, 2020 (the "Final Prospectus"). For a discussion of our liquidity and capital resources for the year endedDecember 31, 2018 , see "Liquidity and Capital Resources" under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operation" in the Final Prospectus. Overview Unity is the world's leading platform for creating and operating interactive, real-time 3D content. Our platform provides a comprehensive set of software solutions to create, run, and monetize interactive, real-time 2D and 3D content for mobile phones, tablets, PCs, consoles, and augmented and virtual reality devices. In the fourth quarter of 2020, we had, on average, a global reach of approximately 2.7 billion monthly active end users, who consumed content created or operated with our solutions on over 20 platforms. In the fourth quarter of 2020, applications built with Unity were downloaded, on average, five billion times per month. Our platform consists of two distinct, but connected and synergistic, sets of solutions: Create Solutions and Operate Solutions. Our Create Solutions are used by content creators-developers, artists, designers, engineers, and architects-to create interactive, real-time 2D and 3D content. Content can be created once and deployed to more than 20 platforms, including Windows, Mac, iOS, Android, PlayStation, Xbox, Nintendo Switch, and the leading augmented and virtual reality platforms, among others. Our Operate Solutions offer customers the ability to grow and engage their end-user base, as well as run and monetize their content with the goal of optimizing end-user acquisition and operational costs, while increasing the lifetime value of their end users. We launched our first game development engine in 2004, bringing together a set of tools, such as rendering, lighting, physics, sound, animation, and user interface, that were designed to address the challenges faced by most game developers. Prior to Unity, developers primarily created these tools individually and repetitively across different target platforms, which was an expensive and time-consuming process. Unity made game development easier and faster. In the year endedDecember 31, 2020 , we built upon our history of innovation by achieving a number of milestones that secured our position as the leading platform for creating and operating interactive, real-time 3D content including those identified below. •MatchMaker, launched inMarch 2020 , is now being used in games like Fall Guys: Ultimate Knockout, Worms Rumble, and Medal of Honor: Above and Beyond. 65 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. •We released MARS, which gives creators professional-grade workflows for augmented and virtual reality development, in the third quarter of 2020. •We launched our Cloud Content Delivery inSeptember 2020 , which offers an enterprise-grade, low-complexity Content Delivery Network (CDN) that helps game developers deliver live game content updates to the right users, at the right time. •We launched ourLEGO microgame inSeptember 2020 , which is designed to put digitalLEGO elements into the hands of new users to get them quickly building, customizing, and sharing their first 3D game in less than an hour. •Because of our deep partnerships withMicrosoft and Sony Interactive Entertainment , our customers were able to launch new game titles on the same day as the new console launches that took place inNovember 2020 . Titles made with Unity included The Falconeer and Morkredd, both Xbox X|S Console Exclusives, and Haven and Overcooked 2: All You Can Eat, for both PlayStation5 and Xbox X|S. Also in the fourth quarter, the release of Apple's M1 chipset and the Microsoft HoloLens 2 Development Edition both included Unity technology deeply integrated, rounding out the variety of new platform types on which developers can deploy and operate real-time 3D applications. •InDecember 2020 , we introducedUnity Forma , a purpose-built tool designed to streamline the creation of configurable, photorealistic digital marketing content and interactive 3D experiences. We continue to invest in research and development and to pursue selective acquisitions and partnerships in order to enhance and expand our platform. Impact of COVID-19 While our total revenue, cash flows, and overall financial condition have not been adversely impacted to date, the COVID-19 pandemic has caused general business disruption worldwide beginning inJanuary 2020 . The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations, and financial condition will depend on future developments that are highly uncertain and cannot be accurately predicted. Although we have and may continue to experience a modest adverse impact on our sales of Create Solutions, though our pipeline of customer opportunities for our Create Solutions was largely back to normal levels by the end of 2020, as well as our Strategic Partnerships, we have seen an increase in demand for our portfolio of products and services within Operate Solutions following the implementation of shelter-in-place orders to mitigate the outbreak of COVID-19, which has resulted in higher levels of end-user engagement in Operate Solutions and an increase in revenue, along with a decrease in operating expense due to materially reduced travel and spending on events and facilities. However, this increased demand for our Operate Solutions and expense reduction will likely moderate over time, particularly as a vaccine becomes widely available, and as shelter-in-place orders and other related measures and community practices evolve. Further, as certain of our customers or partners experience downturns or uncertainty in their own business operations or revenue resulting from the COVID-19 pandemic, they may decrease or delay their spending, request pricing concessions, or seek renegotiations of their contracts, any of which may result in decreased revenue for us. In addition, we may experience customer losses, due to factors including bankruptcy or our customers ceasing operations, which may result in an inability to collect receivables from these customers. In response to the COVID-19 pandemic, we are also requiring or have required substantially all of our employees to work remotely to minimize the risk of the virus to our employees and the communities in which we operate, and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers, and business partners. 66 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. The global impact of the COVID-19 pandemic continues to rapidly evolve, and we will continue to monitor the situation and the effects on our business and operations closely. We do not yet know the full extent of potential impacts on our business or operations or on the global economy as a whole, particularly if the COVID-19 pandemic continues and persists for an extended period of time. Given the uncertainty, we cannot reasonably estimate the impact on our future results of operations, cash flows, or financial condition. For additional details, refer to the section titled "Risk Factors." Key Metrics We monitor the following key metrics to help us evaluate the health of our business, identify trends affecting our growth, formulate goals and objectives, and make strategic decisions. Customers Contributing More Than$100,000 of Revenue We have a history of strong growth in our customer base. We focus on the number of customers that generated more than$100,000 of revenue in the trailing 12 months, as this segment of our customer base represents the majority of our revenue and revenue growth. We expect that trend to continue. We define a customer as an individual or entity that generated revenue during the measurement period. A single organization with multiple divisions, segments, or subsidiaries is generally counted as a single customer, even though we may enter into commercial agreements with multiple parties within that organization. We had 793 and 600 of such customers in the trailing 12 months as ofDecember 31, 2020 and 2019, respectively, demonstrating our ability to grow our revenues with existing customers, and our strong and growing penetration of larger enterprises, includingAAA gaming studios and large organizations in industries beyond gaming. While these customers represented the substantial majority of revenue for the years endedDecember 31, 2020 and 2019, respectively, no one customer accounted for more than 10% of our revenue for either year. Dollar-Based Net Expansion Rate Our ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with our Create and Operate Solutions customers and to increase their use of our platform. We track our performance by measuring our dollar-based net expansion rate, which compares our Create and Operate Solutions revenue from the same set of customers across comparable periods, calculated on a trailing 12-month basis. Our dollar-based net expansion rate as of a period end is calculated as current period revenue divided by prior period revenue. Prior period revenue is the trailing 12-month revenue measured as of such prior period end and includes revenue from all customers that contributed revenue during such trailing 12-month period. Current period revenue is the trailing 12-month revenue from these same customers as of the current period end. Our dollar-based net expansion rate includes the effect of any customer renewals, expansion, contraction, and churn but excludes revenue from new customers in the current period. As of December 31, 2020 2019 Dollar-based net expansion rate 138 % 133 % Our dollar-based net expansion rate as ofDecember 31, 2020 and 2019, was driven primarily by the sales of additional subscriptions and services to our existing Create Solutions customers, expanded usage among our existing Operate Solutions customers, and improvements in cross-selling our solutions to all of our customers. In the years endedDecember 31, 2020 and 2019, increased usage of Operate Solutions drove the improvement in our dollar-based net expansion rate. 67 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. The chart below illustrates our strong relationship with existing customers by presenting our dollar-based net expansion rate as of the end of each of the past eight quarters. [[Image Removed: unity-20201231_g2.jpg]] Results of Operations The following table summarizes our historical consolidated statements of operations data for the periods indicated (in thousands): Year Ended December 31, 2020 2019 2018 Revenue$ 772,445 $ 541,779 $ 380,755 Cost of revenue 172,347 118,597 81,267 Gross profit 600,098 423,182 299,488 Operating expenses Research and development 403,515 255,928 204,071 Sales and marketing 216,416 174,135 134,458 General and administrative 254,979 143,788 91,260 Total operating expenses 874,910 573,851 429,789 Loss from operations (274,812) (150,669) (130,301) Interest expense (1,520) - - Interest income and other expense, net (3,885) (2,573) (2,327) Loss before provision for income taxes (280,217) (153,242) (132,628) Provision for income taxes 2,091 9,948 (1,026) Net loss$ (282,308) $ (163,190) $ (131,602) 68
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The following table sets forth the components of our consolidated statements of operations data as a percentage of revenue for the periods indicated:
Year Ended December 31, 2020 2019 2018 Revenue 100 % 100 % 100 % Cost of revenue 22 22 21 Gross margin 78 78 79 Operating expenses Research and development 52 47 54 Sales and marketing 28 32 35 General and administrative 33 27 24 Total operating expenses 113 106 113 Loss from operations (36) (28) (34) Interest expense - - - Interest income and other expense, net (1) - (1) Loss before provision for income taxes (37) (28) (35) Provision for income taxes - 2 - Net loss (37) % (30) % (35) % Revenue We derive revenue from Create Solutions, Operate Solutions, and Strategic Partnerships and Other. Create Solutions We generate Create Solutions revenue primarily through the sale of subscription fee arrangements for the use of our products and related support services. We offer subscription plans at various price points and recognize revenue over a service period that generally ranges from one to three years. We typically bill our customers on a monthly, quarterly or annual basis, depending on the size of the contract. As a result of billing our customers in advance, we record deferred revenue, and a portion of the revenue we report in each period is attributable to the recognition of deferred revenue related to subscription and support agreements that we entered into during previous periods. We generate additional Create Solutions revenue from the sale of professional services to our subscription customers. These services primarily consist of consulting, integration, training and custom application and workflow development, and may be billed in advance or on a time and materials basis. Operate Solutions We generate Operate Solutions revenue through a combination of revenue-share and usage-based business models that we manage as a portfolio of products and services. 69 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Our monetization products are primarily based on a revenue-share model. These products were introduced in 2014 as our first set of Operate Solutions products and currently account for a substantial majority of our Operate Solutions revenue. We recognize monetization revenue primarily when an end user installs an application after seeing an advertisement (contracted on a cost-per-install basis), and to a lesser extent when an advertisement starts (contracted on a cost-per-impression basis). Our revenue represents the amount we retain from the transaction we are facilitating through our Unified Auction. Actions by operating system platform providers or application stores such as Apple or Google may affect the manner in which we or our customers collect, use and share data from end-user devices. InJune 2020 , Apple announced plans to require applications using its mobile operating system, iOS, to affirmatively (on an opt-in basis) obtain an end user's permission to "track them across apps or websites owned by other companies" or access their device's advertising identifier for advertising and advertising measurement purposes, as well as other restrictions. The exact timing and manner in which these plans will be implemented and the effect on our revenue are not yet clear, but we expect these changes to adversely affect our revenue from our monetization products and potentially other Operate Solutions, and such impact could be material. We also provide cloud-based services to support the ongoing operation of games and applications. These include application hosting services, as well as end-user engagement tools and voice chat services. These services are generally sold based on usage and billed monthly in arrears. Some of our usage-based contracts include a minimum fixed-fee usage amount. We expect that our Operate Solutions beyond monetization, including cloud operations and hosting services, such as Multiplay, which we introduced in 2018, as well asVivox and deltaDNA, both introduced in 2019, will grow as a percentage of our revenue in the long term as we further scale these newer products and services and as we launch additional solutions for gaming customers as well as customers in other industries. Strategic Partnerships and Other We generate Strategic Partnerships revenue primarily from partnership contracts with hardware, operating system, device, game console, and other technology providers. Typically, we recognize revenue from these contracts as services are performed. These partnerships are typically multi-year software development arrangements with payments that are either made in advance on a quarterly basis or milestone-based. In addition, certain partners pay us royalties based on the sales of applications sold on their platform that incorporate or use our customized software. We generate Other revenue primarily from our share of sales from ourAsset Store , a marketplace and scaled aggregator for software, content, and tools used in the creation of real-time interactive games and applications, and from ourVerified Solutions Partners , which sell software and tools certified for quality and compatibility with our platform. 70 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Our total revenue is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Create Solutions$ 231,314 $ 168,626 $ 62,688 37 % Operate Solutions 471,161 293,317 177,844 61 % Strategic Partnerships and Other 69,970 79,836 (9,866) (12) % Total revenue$ 772,445 $ 541,779 $ 230,666 43 % The increase in revenue in the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 was substantially due to revenue growth among existing customers. In the year endedDecember 31, 2020 , the increase in revenue was primarily due to an increase in revenue from our Create Solutions and Operate Solutions, including an increase of approximately$25 million as a result of the COVID-19 pandemic, offsetting a decrease inStrategic Partnership revenue primarily due to deal delays resulting from the impact of the COVID-19 pandemic and the retirement of certain partners' product offerings. Create Solutions revenue growth was positively impacted by the second quarter 2020 Finger Food acquisition, offset in part from a slowdown of sales cycles due to the impact of the COVID-19 pandemic, though we saw signs of recovery beginning in the second half of the year. The pandemic-related slowdown of sales cycles initially began inAsia during the first quarter of 2020 and was followed by geographies outside ofAsia in the second quarter of 2020. Within Operate Solutions, the substantial majority of our revenue growth was driven by an increase in revenue per customer as customers increased their usage across our Operate portfolio of products and services due in part to the higher levels of end-user engagement as a result of COVID-19 shelter-in-place orders. Cost of Revenue, Gross Profit, and Gross Margin Cost of revenue consists primarily of hosting expenses, personnel costs (including salaries, benefits, and stock-based compensation) for employees associated with our product support and professional services organizations, allocated overhead (including facilities, information technology, and security costs), third party license fees, and credit card fees, as well as amortization of related capitalized software and depreciation of related property and equipment. Gross profit, or revenue less cost of revenue, has been and will continue to be affected by various factors, including our product mix, the costs associated with third-party hosting services, and the extent to which we expand and drive efficiencies in our hosting costs, professional services, and customer support organizations. We expect our gross profit to increase in absolute dollars, but we expect our gross profit as a percentage of revenue, or gross margin, to fluctuate from period to period. Our cost of revenue, gross profit, and gross margin are summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Cost of revenue$ 172,347 $ 118,597 $ 53,750 45 % Gross profit$ 600,098 $ 423,182 $ 176,916 42 % Gross margin 78 % 78 % - % Cost of revenue for the year endedDecember 31, 2020 increased primarily due to an increase of$21.8 million in hosting costs supporting our growth in our Create Solutions and Operate Solutions, as well as an increase of$24.7 million in personnel-related and professional services expenses to support our Create Solutions and Strategic Partnerships. The increase in personnel-related expenses was also driven by an increase in headcount, and a one-time cumulative stock-based compensation expense of$4.0 million related to all then-outstanding RSUs as the liquidity event vesting condition was satisfied upon completion of our IPO. 71 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Operating Expenses Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The most significant component of our operating expenses is personnel-related costs, including salaries and wages, sales commissions, bonuses, benefits, stock-based compensation, and payroll taxes. We estimate that materially reduced travel and spending on events and facilities due to COVID-19 protocols and precautions reduced our operating expenses by approximately$40 million in the year endedDecember 31, 2020 . These savings are unlikely to be repeated in future years. Research and Development Research and development expenses primarily consist of personnel-related costs for the design and development of our platform, third-party software services, professional services, and allocated overhead. We expense research and development expenses as they are incurred. We expect our research and development expenses to increase in absolute dollars and may fluctuate as a percentage of revenue from period to period as we expand our teams to develop new products, expand features and functionality with existing products, and enter new markets. Research and development expense is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Research and development$ 403,515 $ 255,928 $ 147,587 58 % Research and development expense for the year endedDecember 31, 2020 increased primarily due to an increase of$123.8 million in personnel-related expenses driven by an increase in headcount to support continued product innovation, and a one-time cumulative stock-based compensation expense of$25.2 million related to all then-outstanding RSUs as the liquidity event vesting condition was satisfied upon completion of our IPO. In addition, IT hosting expense increased by$13.0 million due to growing data and compute needs. Sales and Marketing Our sales and marketing expenses consist primarily of personnel-related costs; advertising and marketing programs, including digital account-based marketing, user events such as developer-centric conferences and our annual Unite user conferences; and allocated overhead. We expect that our sales and marketing expense will increase in absolute dollars as we hire additional personnel, increase our account-based marketing, direct marketing and community outreach activities, invest in additional tools and technologies, and continue to build brand awareness. Our expenses may fluctuate as a percentage of revenue from period to period. Sales and marketing expense is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Sales and marketing$ 216,416 $ 174,135 $ 42,281 24 % Sales and marketing expense for the year endedDecember 31, 2020 increased primarily due to an increase of$43.9 million in personnel-related expenses driven by an increase in headcount to support the growth of our sales and marketing teams and a one-time cumulative stock-based compensation expense of$7.9 million related to all then-outstanding RSUs as the liquidity event vesting condition was satisfied upon completion of our IPO. In addition, marketing and advertising expense increased by$9.2 million due to new product initiatives. This increase was partially offset by an$11.7 million reduction in conference and event expenses due to the COVID-19 pandemic. 72 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. General and Administrative Our general and administrative expenses primarily consist of personnel-related costs for finance, legal, human resources, and administrative employees; professional fees for external legal, accounting, and other professional services; and allocated overhead. We expect that our general and administrative expenses will increase in absolute dollars and may fluctuate as a percentage of revenue from period to period as we scale to support the growth of our business. General and administrative expense is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % General and administrative$ 254,979 $ 143,788 $ 111,191 77 % General and administrative expense for the year endedDecember 31, 2020 increased primarily due to a one-time charge of$63.6 million related to the donation of 750,000 shares of our common stock to a charitable foundation. In addition, personnel-related costs increased by$39.8 million , driven by an increase in headcount to support the growth of our general and administrative teams and also included a one-time cumulative stock-based compensation expense of$10.7 million related to all then-outstanding RSUs as the liquidity event vesting condition was satisfied upon completion of our IPO. Interest Expense Interest expense consists primarily of interest expense associated with our Credit Agreement. Interest expense is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Interest expense$ (1,520) $ -$ (1,520) * * Not meaningful Interest expense was recognized in the year endedDecember 31, 2020 on the outstanding balance from our$125.0 million credit facility, which was fully drawn inMarch 2020 and repaid inSeptember 2020 . We had no outstanding debt during 2019. Interest Income and Other Expense, Net Interest income and other expense, net, consists primarily of interest income earned on our cash, cash equivalents, and marketable securities, amortization of premium arising at acquisition of marketable securities, foreign currency remeasurement gains and losses, and foreign currency transaction gains and losses. As we have expanded our global operations, our exposure to fluctuations in foreign currencies has increased, and we expect this to continue. Interest income and other expense, net, is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Interest income and other expense, net$ (3,885) $ (2,573) $ (1,312) 51 %
Interest income and other expense, net, for the year ended
73 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Provision for Income Taxes Provision for income taxes consists primarily of income taxes in certain foreign jurisdictions where we conduct business. As we have expanded our global operations, we have incurred increased foreign tax expense, and we expect this to continue. We have a valuation allowance against certain of our deferred tax assets, including net operating loss carryforwards and tax credits related primarily to research and development. Our overall effective income tax rate in future periods may be affected by the geographic mix of earnings in the countries in which we operate. Our future effective tax rate may also be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles in the jurisdictions in which we conduct business. See Note 14, "Income Taxes," of the Notes to Consolidated Financial Statements. Provision for income taxes is summarized as follows (in thousands, except percentages): Year Ended December 31, Change 2020 2019 Amount % Provision for income taxes$ 2,091 $ 9,948 $ (7,857) (79) % Provision for income taxes for the year endedDecember 31, 2020 decreased primarily due to a one-time intercompany transaction with ourFinland subsidiary in the same period ended 2019. Non-GAAP Financial Measures To supplement our consolidated financial statements prepared and presented in accordance with generally accepted accounting principles inthe United States , or GAAP, we use certain non-GAAP performance financial measures, as described below, to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe the following non-GAAP measures are useful in evaluating our operating performance. We are presenting these non-GAAP financial measures because we believe, when taken collectively, they may be helpful to investors because they provide consistency and comparability with past financial performance. In the future, we may also exclude non-recurring expenses and other expenses that do not reflect our overall operating results. However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. As a result, our non-GAAP financial measures are presented for supplemental informational purposes only and should not be considered in isolation or as a substitute for our consolidated financial statements presented in accordance with GAAP. Non-GAAP Gross Profit and Non-GAAP Loss from Operations We define non-GAAP gross profit as gross profit excluding stock-based compensation expense and employer tax related to employee stock transactions. We define non-GAAP loss from operations as loss from operations excluding stock-based compensation expense, employer tax related to employee stock transactions, amortization of acquired intangible assets expense, and non-cash charitable contribution expense. We use non-GAAP gross profit and non-GAAP loss from operations in conjunction with traditional GAAP measures to evaluate our financial performance. We believe that non-GAAP gross profit and non-GAAP loss from operations provide our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations, as these metrics excludes stock-based compensation expense, employer tax related to employee stock transactions, amortization of acquired intangible assets expense, and non-cash charitable contribution expense, which we do not consider to be indicative of our overall operating performance. 74 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Non-GAAP gross profit and non-GAAP loss from operations have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: •they exclude expense associated with our equity compensation plan, although equity compensation has been, and will continue to be, an important part of our compensation strategy; •non-GAAP loss from operations excludes the expense of amortization of acquired intangible assets, and although these are non-cash expenses, the assets being amortized may have to be replaced in the future and non-GAAP loss from operations does not reflect cash expenditure for such replacements; •non-GAAP loss from operations excludes the expense associated with the charitable contribution of common stock to a donor-advised fund, and although this is a non-cash expense, we may make similar charitable contributions in the future; and •the expenses and other items that we exclude in our calculation of non-GAAP gross profit and non-GAAP loss from operations may differ from the expenses and other items, if any, that other companies may exclude from this measure or similarly titled measures, which reduces their usefulness as comparative measures. The following table presents a reconciliation of our non-GAAP gross profit to our GAAP gross profit, the most directly comparable measure as determined in accordance with GAAP, for the periods presented (in thousands): Year Ended December 31, 2020 2019 GAAP gross profit$ 600,098 $ 423,182 Add: Stock-based compensation expense 10,626 3,198 Employer tax related to employee stock transactions 1,117 193 Non-GAAP gross profit$ 611,841 $ 426,573 GAAP gross margin 78 % 78 % Non-GAAP gross margin 79 % 79 % Non-GAAP gross margin was relatively flat for the year endedDecember 31, 2020 as compared to the same period in 2019. The following table presents a reconciliation of our non-GAAP loss from operations to our GAAP loss from operations, the most directly comparable measure as determined in accordance with GAAP, for the periods presented (in thousands): Year Ended December 31, 2020 2019 GAAP loss from operations$ (274,812) $ (150,669) Add: Stock-based compensation expense 134,629 44,480 Employer tax related to employee stock transactions 8,176 2,808 Amortization of intangible assets expense 17,755 11,570 Charitable contribution to donor-advised fund 63,615 - Non-GAAP loss from operations$ (50,637) $ (91,811) 75
-------------------------------------------------------------------------------- Table of Contents Unity Software Inc. A substantial part of the year-over-year improvement in our non-GAAP loss from operations was driven in part by savings related to the COVID-19 pandemic, primarily related to travel, marketing, and facilities. Non-GAAP Net Loss and Non-GAAP Net Loss per Share We define non-GAAP net loss and non-GAAP net loss per share as net loss and net loss per share excluding stock-based compensation expense, employer tax related to employee stock transactions, amortization expense of acquired intangible assets, and non-cash charitable contribution expense, as well as the related tax effects of these items. Non-GAAP net loss per share also adds back expense relating to deemed dividends representing excess paid over initial issuance price to repurchase convertible preferred stock. We use non-GAAP net loss and non-GAAP net loss per share in conjunction with traditional GAAP measures to evaluate our financial performance. We believe that these non-GAAP measures provide our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations. Non-GAAP net loss and non-GAAP net loss per share have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: •they exclude expense associated with our equity compensation plan, although equity compensation has been, and will continue to be, an important part of our compensation strategy; •they exclude the expense of amortization of acquired intangible assets, and although these are non-cash expenses, the assets being amortized may have to be replaced in the future and non-GAAP loss from operations does not reflect cash expenditure for such replacements; •they exclude the expense associated with the charitable contribution of common stock to a donor-advised fund, and although this is a non-cash expense, we may make similar charitable contributions in the future; •as further described below, we must make certain assumptions in order to determine the income tax effect adjustment for non-GAAP net loss, which assumptions may not prove to be accurate; and •the expenses and other items that we exclude in our calculation of non-GAAP net loss and non-GAAP net loss per share may differ from the expenses and other items, if any, that other companies may exclude from this measure or similarly titled measures, which reduces their usefulness as comparative measures. Income Tax Effects of Non-GAAP Adjustments We utilize a fixed projected tax rate in our computation of non-GAAP income tax effects to provide better consistency across interim reporting periods. In projecting this non-GAAP tax rate, we utilize a financial projection that excludes the direct impact of the non-GAAP adjustments described above, and eliminates the effects of non-recurring and period specific items which can vary in size and frequency. The projected rate considers other factors such as our current operating structure, existing tax positions in various jurisdictions, and key legislation in major jurisdictions where we operate. For the year endedDecember 31, 2020 , the non-GAAP tax rate was (17)%. 76 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. The following table presents a reconciliation of our non-GAAP net loss and non-GAAP net loss per share to our GAAP net loss and GAAP net loss per share, respectively, which are the most directly comparable measures as determined in accordance with GAAP, for the periods presented (in thousands, except per share data): Year Ended December 31, 2020 2019 GAAP net loss$ (282,308) (163,190) Add: Stock-based compensation expense 134,629 44,480 Employer tax related to employee stock transactions 8,176 2,808 Amortization of intangible assets expense 17,755 11,570 Charitable contribution to donor-advised fund 63,615 - Income tax effect of non-GAAP adjustments (7,437) (8,671) Non-GAAP net loss
GAAP net loss per share attributable to our common stockholders, basic and diluted
1.27 0.44
Non-GAAP net loss per share attributable to our common stockholders, basic and diluted
Weighted-average common shares used in GAAP net loss per share computation, basic and diluted
169,973 114,442
Weighted-average common shares used in non-GAAP net loss per share computation, basic and diluted
169,973 114,442 Free Cash Flow We define free cash flow as net cash provided by (used in) operating activities less cash used for purchases of property and equipment. We believe that free cash flow is a useful indicator of liquidity as it measures our ability to generate cash, or our need to access additional sources of cash, to fund operations and investments. Free cash flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: •it is not a substitute for net cash used in operating activities; •other companies may calculate free cash flow or similarly titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a tool for comparison; and •the utility of free cash flow is further limited as it does not reflect our future contractual commitments and does not represent the total increase or decrease in our cash balance for any given period. 77 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable measure as determined in accordance with GAAP, for the periods presented (in thousands): Year Ended December 31, 2020 2019 Net cash provided by (used in) operating activities$ 19,913 $ (67,936) Less: Purchase of property and equipment (40,156) (27,035) Free cash flow$ (20,243) $ (94,971) Net cash used in investing activities$ (575,190) $ (219,541) Net cash provided by financing activities $
1,701,455
The year-over-year increase in free cash flow was primarily due to strong performance within our Operate Solutions, as well as savings in operational expenses due to COVID-19. We expect our free cash flow to remain volatile from quarter to quarter and likely to decline in 2021. Liquidity and Capital Resources Since inception, we have financed our operations primarily through the net proceeds we have received from the sales of our convertible preferred stock and common stock and through payments received from customers using our platform. As ofDecember 31, 2020 , our principal sources of liquidity were cash, cash equivalents, and marketable securities totaling$1,752.0 million , which were primarily held for working capital purposes. Since our inception, we have generated losses from our operations as reflected in our accumulated deficit of$797.5 million as ofDecember 31, 2020 . We expect to continue to incur operating losses for the foreseeable future due to the investments we will continue to make in research and development, sales and marketing, and general and administrative. As a result, we may require additional capital to execute our strategic initiatives to grow our business. We believe our existing sources of liquidity will be sufficient to meet our working capital and capital expenditures for at least the next 12 months. Our future capital requirements, however, will depend on many factors, including our growth rate; the timing and extent of spending to support our research and development efforts; capital expenditures to build out new facilities and purchase hardware and software; the expansion of sales and marketing activities; and our continued need to invest in our IT infrastructure to support our growth. In addition, we may enter into additional strategic partnerships as well as agreements to acquire or invest in complementary products, teams and technologies, including intellectual property rights, which could increase our cash requirements. For example, in the years endedDecember 31, 2020 and 2019, we acquired three and six companies, respectively, with products and technologies that support our growth strategies, which reduced ourDecember 31, 2020 and 2019 cash balance by$53.2 million and$192.5 million , respectively. As a result of these and other factors, we may choose or be required to seek additional equity or debt financing sooner than we currently anticipate. If additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when required, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, results of operations, and financial condition would be adversely affected. 78 -------------------------------------------------------------------------------- Table of ContentsUnity Software Inc.
Our changes in cash flows were as follows (in thousands):
Year
Ended
2020 2019 2018 Net cash provided by (used in) operating activities$ 19,913 $ (67,936) $ (81,059) Net cash used in investing activities (575,190) (219,541) (40,043) Net cash provided by financing activities 1,701,455 161,472 148,251 Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash 673 (172) (8) Net change in cash, cash equivalents, and restricted cash$ 1,146,851 $
(126,177)
Cash Provided by (Used in) Operating Activities During the year endedDecember 31, 2020 , cash provided by operating activities was$19.9 million , which consisted of a net loss of$282.3 million , adjusted by non-cash charges of$244.5 million and net cash inflows from the change in net operating assets and liabilities of$57.8 million . The non-cash charges primarily consisted of depreciation and amortization of$43.0 million , stock-based compensation of$134.6 million , and a common stock charitable donation expense of$63.6 million . The net cash inflows from the change in our net operating assets and liabilities was primarily due to a$41.6 million increase in accrued expenses and other current liabilities, a$44.6 million increase in publisher payables, and a$37.4 million increase in deferred revenue. This was partially offset by a$63.3 million increase in accounts receivable and a$13.0 million increase in other current assets. A substantial portion of our accounts receivable balance comes from advertising partners and is offset by an accounts payable amount due to our publishers (Operate Solutions customers). However, the payment terms that we offer our advertising partners are generally shorter than the payment terms with our publishers (Operate Solutions customers). As such, our cash flows fluctuate from period to period due to revenue seasonality, timing of billings, collections, and publisher payments. Historical cash flows are not necessarily indicative of our results in any future period. During the year endedDecember 31, 2019 , cash used in operating activities was$67.9 million , which consisted of a net loss of$163.2 million , adjusted by non-cash charges of$75.7 million and net cash inflows from the change in net operating assets and liabilities of$19.5 million . The non-cash charges primarily consisted of stock-based compensation of$44.5 million and depreciation and amortization of$31.1 million . The net cash inflows from the change in our net operating assets and liabilities was primarily due to a$31.1 million increase in deferred revenue, an increase in publisher payables of$20.2 million , and a$13.2 million increase in income and other taxes payable. This was partially offset by a$49.4 million increase in accounts receivable, all due to an increase in sales, including in the fourth quarter, which has historically been our strongest quarter for new business within our Create Solutions business and for usage levels within our Operate Solutions business. Cash Used in Investing Activities During the year endedDecember 31, 2020 , cash used in investing activities was$575.2 million , consisting of the purchase of marketable securities of$482.5 million , cash used in acquisitions of$53.2 million , and capital expenditures of$40.2 million . During the year endedDecember 31, 2019 , cash used in investing activities was$219.5 million , consisting of cash used in acquisitions of$192.5 million and capital expenditures of$27.0 million . 79 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Cash Provided by Financing Activities During the year endedDecember 31, 2020 , cash provided by financing activities was$1,701.5 million , primarily consisting of net proceeds of$1,417.6 million from our initial public offering, net proceeds of$250.0 million from the issuance of convertible preferred stock and common stock, proceeds of$125.0 million from the revolving loan facility, and proceeds of$25.4 million from the exercise of stock options. The net cash outflows from financing activities was primarily due to the$125.0 million repayment of principal on our revolving loan facility. During the year endedDecember 31, 2019 , cash provided by financing activities was$161.5 million , consisting of proceeds from the issuance of convertible preferred stock and common stock of$585.1 million and stock option exercises of$11.8 million , partially offset by$435.1 million used for the repurchase of our stock and the purchase of shares of our common stock and vested stock options pursuant to a tender offer, and$0.4 million of debt issuance costs in connection with our$125.0 million Credit Agreement. Contractual Obligations The following table summarizes our contractual obligations as ofDecember 31, 2020 (in thousands): Payments Due by Period More than 5 Total Less than 1 Year 1-3 Years 3-5 Years Years Operating leases (1)$ 141,762 $ 30,176$ 49,567 $ 32,735 $ 29,284 Purchase commitments (2) 153,870 48,502 89,743 15,625 - Total (3)$ 295,632 $ 78,678$ 139,310 $ 48,360 $ 29,284 (1) Operating lease obligations consist primarily of obligations for real estate. (2) The substantial majority of our purchase commitments are related to agreements with our data center hosting providers. (3) This table generally excludes amounts related to income tax liabilities for uncertain tax positions, since we cannot predict with reasonable reliability the timing of cash settlements to the respective taxing authorities. Off-Balance Sheet Arrangements We have not entered into any off-balance sheet arrangements and did not have any material holdings in variable interest entities as ofDecember 31, 2020 . Critical Accounting Policies and Estimates Management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles, orU.S. GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities and the amount of revenue and expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and any such differences may be material. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates. 80 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Revenue Recognition We generate revenue through three sources: (1) Create Solutions, which is composed primarily of our subscription offerings and professional services; (2) Operate Solutions, which includes our monetization services, hosting, and multiplayer services, and voice services; and (3) Strategic Partnerships and Other, which are primarily arrangements with strategic hardware, operating system, device, game console, and other technology providers for the customization and development of our software to enable interoperability with these platforms. We evaluate and recognize revenue by: •identifying the contract(s) with the customer; •identifying the performance obligation(s) in the contract(s); •determining the transaction price; •allocating the transaction price to performance obligation(s) in the contract(s); and •recognizing revenue as each performance obligation is satisfied through the transfer of a promised good or service to a customer which we refer to as a transfer of control. Our contracts are generally non-cancellable. Once we have determined the transaction price, the total transaction price is allocated to each performance obligation in the contract on a relative stand-alone selling price basis, or SSP. The determination of SSP for each distinct performance obligation requires judgment. Generally, we determine SSP using observable pricing, which takes into consideration market conditions and customer specific factors. When observable pricing is not available, we use cost plus margin analysis to determine SSP. Revenue is recognized upon the transfer of control of promised products and services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We use the output method for our Create Solutions and Operate Solutions contracts, and generally use the input method for ourStrategic Partnership contracts. We determined that these methods are the most appropriate measure of progress as they faithfully represent when the value of the services are simultaneously received and consumed by the customer, and control is transferred. For advertisements placed through the Unified Auction, we evaluate whether we are the principal (i.e., report revenue on a gross basis) or the agent (i.e., report revenue on a net basis). The evaluation to present revenue on a gross versus net basis requires significant judgment. We have concluded that the publisher is our customer and we are the agent in facilitating the fulfillment of the advertising inventory in the Unified Auction primarily because we do not control the advertising inventory prior to the placement of an advertisement. Typically we do not retain a share of the revenue generated through Unity IAP (In-App Purchases). Stock-Based Compensation We measure stock-based compensation expense based on the estimated grant date fair value of the awards. Restricted stock units, or RSUs, granted by us have a service condition, which is generally satisfied over four years, and RSUs granted prior to our IPO were also subject to a liquidity event vesting condition, which was satisfied on the completion of our IPO. Stock options granted by us only have a service vesting condition, which is generally a vesting period of four years. We account for forfeitures as they occur. We estimate the fair value of stock options using the Black-Scholes option-pricing model and recognize expense on a straight-line basis over the requisite service period of the awards. The Black-Scholes option pricing model requires certain subjective inputs and assumptions, including the fair value of our common stock, the expected term, risk-free interest rates, expected stock price volatility, and expected dividend yield of our common stock. The assumptions used to determine the fair value of the option awards represent management's best estimates. These estimates involve inherent uncertainties and the application of management's judgment. These assumptions and estimates are as follows: 81 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. •Fair Value of Common Stock-Because our common stock was not yet publicly traded prior to our IPO, we estimated the fair value of common stock, as discussed below in the section titled "-Common Stock Valuations." •Expected term-The expected term represents the period that our stock-based awards are expected to be outstanding. The expected term assumptions were determined based on the vesting terms, estimated exercise behavior, post-vesting cancellations and contractual lives of the awards. •Risk-free interest rates-The risk-free interest rate is based on the implied yields in effect at the time of the grant ofU.S. Treasury notes with terms approximately equal to the expected term of the award. •Expected stock price volatility-We estimate the volatility of our common stock on the date of grant based on the average historical stock price volatility of comparable publicly-traded companies in our industry group as our common stock has only been publicly traded for a short period of time. •Expected dividend yield-Our expected dividend yield is zero, as we have not paid and do not anticipate paying dividends on our common stock. Common Stock Valuations Prior to our IPO, given the absence of a public trading market for our common stock, and in accordance with theAmerican Institute of Certified Public Accountants Accounting and Valuation Guide : Valuation of Privately-Held Company Equity Securities Issued as Compensation, our board of directors along with management exercised its reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of fair value of our common stock, including: •the prices at which we or other holders sold our common and redeemable convertible preferred stock to outside investors in arms-length transactions; •independent third-party valuations of our common stock; •the rights, preferences and privileges of our redeemable convertible preferred stock relative to those of our common stock; •our financial condition, results of operations and capital resources; •the industry outlook; •the valuation of comparable companies; •the lack of marketability of our common stock; •the fact that option and RSU grants have involved rights in illiquid securities in a private company; •the likelihood of achieving a liquidity event, such as an initial public offering or a sale of our company given prevailing market conditions; •the history and nature of our business, industry trends and competitive environment; and •general economic outlook including economic growth, inflation and unemployment, interest rate environment and global economic trends. Following the completion of our IPO, there is an active market for our common stock, so we no longer apply these valuation approaches. Accounting for Business Combinations The assets acquired and liabilities assumed in a business combination are recorded based on their estimated fair values at the acquisition date. Any residual purchase price is recorded as goodwill. 82 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Accounting for business combinations requires us to make significant estimates and assumptions, especially with respect to intangible assets. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates used in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: •future expected cash flows from acquired developed technologies; •the acquired company's trade name, trademark and existing customer relationship, as well as assumptions about the period of time the acquired trade name and trademark will continue to be used in our product portfolio; •the expected use of the acquired assets; and •discount rates. These estimates are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.Goodwill and Intangible Assets We evaluate and test the recoverability of our goodwill for impairment at least annually during our fourth quarter of each calendar year or more often if and when circumstances indicate that goodwill may not be recoverable. We use judgments when assessing qualitative factors of impairment that include macroeconomic conditions, other relevant events and factors affecting the market and industry, our financial performance, and other factors. To the extent we determine that it is more likely than not that the fair value of our single reporting unit is less than its carrying value, a quantitative test is then performed. We evaluate intangible assets other than goodwill for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. This includes but is not limited to significant adverse changes in business climate, market conditions or other events that indicate an asset's carrying amount may not be recoverable. Recoverability of the intangible assets is measured by comparing the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate. If the undiscounted cash flows used in the test for recoverability are less than the carrying amount of these assets, the carrying amount of such assets is reduced to fair value. We also evaluate the estimated remaining useful lives of intangible assets for changes in circumstances that warrant a revision to the remaining periods of amortization. Income Taxes We are subject to income taxes inthe United States and numerous foreign jurisdictions. Significant judgment is required in determining the provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We use the asset and liability method under FASB ASC Topic 740, Income Taxes, when accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax expense or benefit is the result of changes in the deferred tax asset and liability. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income, and ongoing tax planning strategies in assessing the need for a valuation allowance. 83 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. We recognize interest and penalties related to unrecognized tax benefits within income tax expense in the accompanying consolidated statement of operations. JOBS Act Accounting Election We are an emerging growth company, as defined in the JOBS Act. Under the JOBS Act, emerging growth companies may delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have elected to use this extended transition period to enable us to comply with certain new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. Recent Accounting Pronouncements See Note 2, "Summary of Accounting Pronouncements," of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Foreign currency exchange risk The vast majority of our cash generated from revenue is denominated inU.S. dollars, with a small amount denominated in foreign currencies. Our expenses are generally denominated in the currencies of the jurisdictions in which we conduct our operations. Our results of current and future operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have had a material impact on our historical consolidated financial statements. As the impact of foreign currency exchange rates has not been material to our historical operating results, we have not entered into derivative or hedging transactions, but we may do so in the future if our exposure to foreign currency becomes more significant. Interest rate risk We had cash, cash equivalents, and marketable securities totaling$1,752.0 million as ofDecember 31, 2020 and we had cash totaling$130.0 million as ofDecember 31, 2019 . Cash equivalents and marketable securities were invested primarily in marketable securities consisting ofU.S. treasury securities, commercial paper, corporate bonds, asset-backed securities, supranational bonds, and money market funds. The cash, cash equivalents, and marketable securities were held primarily for working capital purposes. Our investment portfolios are managed to preserve capital and meet liquidity needs. We do not enter into investments for trading or speculative purposes. 84 -------------------------------------------------------------------------------- Table of Contents Unity Software Inc. Our cash equivalents and our portfolio of debt securities are subject to market risk due to changes in interest rates. Fixed rate securities may have their market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fluctuate due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However, because we classify our debt securities as "available-for-sale," no gains or losses are recognized in income due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other-than-temporary. An immediate increase of 100 basis points in interest rates would have resulted in a$3.7 million market value reduction in our investment portfolio as ofDecember 31, 2020 . This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur. Fluctuations in the value of our investment securities caused by a change in interest rates (unrealized gains or losses on the carrying value) are recorded in accumulated other comprehensive loss and are realized only if we sell the underlying securities before maturity. We are also subject to interest rate risk in connection with our Credit Agreement. Interest rate changes generally impact the amount of our interest payments and, therefore, our future net income and cash flows, assuming other factors held constant. Assuming the amounts outstanding under our Credit Agreement are fully drawn, a hypothetical 10% change in interest rates would not have a material impact on our consolidated financial statements. 85
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Table of ContentsUnity Software Inc.
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